Perched on a cliff – now taking a step forward!
At our CFO Roundtable in Jodhpur, Vivek Aggarwal of CIBIL raised a pertinent point on the issue of Government finances. He correctly observed that Government expenditure is presented as a percentage of Gross Domestic Product, as are the various measures of deficits. He proposed that we undertake an exercise, if only to present a more realistic perspective, using the methodology adopted by commercial enterprises – simply put, that we look at these metrics as a percentage of revenue. This paper will provide some data along these lines but perhaps more importantly, raise concerns that the current state of fiscal affairs has perched India’s economy precariously. Frankly, it could go either way, and a disaster might not be far.
In 2006-07, tax and other revenue receipts amounted to Rs 4.3 tn while total expenses were Rs 5.8 tn, implying a fiscal deficit of Rs 1.4 tn. When measured against GDP, the deficit amounted to 3.3%. From conventional benchmarks, this would appear to be an acceptable figure. However, when measured against revenue, the deficit was 32%. This was funded largely by Government borrowings of Rs 1.1 tn (other capital receipts like loan recoveries and fresh deposits in Government saving schemes, contributed the balance). Effectively therefore, the Government over-spent its income by a third and financed one fifth of its expenditure through borrowings. Over a period of five years, this situation changed drastically – for the worse.
In 2011-12, Government revenue stood at Rs 7.7 tn while expenses were Rs 13.2 tn. This amounted to a shortfall of Rs 5.2 tn which again had to be funded largely by borrowings (Rs 4.4 tn). As a percentage of GDP, the fiscal deficit was 5.9% but as a percentage of revenue, it was 68%. Effectively therefore, the Government now borrows almost two thirds of what it earns and one third of what it spends.
The Treasury assumes that tax receipts will continue to rise as the economy expands. Therefore, over time and through prudent management of costs, it may be possible to reduce the income-expenditure gap as a proportion of GDP. But the reality is that a large chunk of Government expenditure comprises of committed payments – for instance, interest payments at Rs 2.8 tn, defence spending at Rs 1.8 tn and appallingly, subsidies at Rs 2.2 tn. None of these can be tinkered with in the context of India’s political structure. Additionally, the welfare programmes instituted over the past few years will entail spending commitments to service the NREGS, oil and fertiliser subsidies and now, the food subsidy bill which will cost Rs 1.5 tn per annum. This alone is three times the NREGS expenditure.
The total liability of the Union of India, which encompasses sovereign debt, pensions and savings liabilities, stands at Rs 43 tn, half the country’s GDP. Over the past few years, this has increased by Rs 4 tn or thereabouts every year, largely matching the fiscal deficit. Servicing this debt entails an annual outgo of Rs 2.8 tn, more than half the deficit itself. Basically, the Government of India spends ~70% more than it earns, and half of that is simply to repay interest commitments on past borrowings. It rarely repays principals and simply borrows more to roll over past loans when they come up for renewal. Even from generous benchmarks, this situation can only be described as an internal debt trap.
Governments manage to chug along when economic growth is high and tax revenues are buoyant – fiscal indicators measured as percentages of GDP can then be made to look good. But in the wake of a slowing economy and consequently falling revenues, this logic unravels and ‘committed expenditures’ begin to hurt. As the figures demonstrate, the present fiscal situation borders on being calamitous.
Euro crises and global financial markets aside, the fact is that our national finances have been badly managed. Even if the global economy were to recover, Indian policy makers would have a lot of hard thinking to do. The capital flows that have dried up are not so much a reflection of global market conditions as the Government pretends and is painstakingly trying to convince those that would listen, as it is a reflection of a fall in investor confidence. Investors understand that mismanaged budgets lead to price instability, falling investment and eventually a decline in future growth. They see no appetite within Government to undertake reforming measures that would alleviate these factors and therefore, attract capital. They realise that with the Government in dormancy, India is quickly losing the plot.
To make things worse, recent decisions by Ministries reek of arrogance. The Vodafone tax case and the denial of Reliance’s exploration expenditures previously agreed have frightened not only international companies but created mistrust among foreign Governments. A country, which cannot be trusted is hardly one that would generate interest to do business with. This is starkly corroborated by India’s own business community, which is now actively pursuing investment opportunities offshore, as there seems little faith left that things will improve in a hurry on the domestic front.
To top it all, there is a high probability that Greece will exit the Eurozone and the contagion, which will affect peripheral economies such as Ireland and Portugal but even core ones such as Spain. The Euro authorities neither have a plan nor the financial ammunition to prevent this crisis. The inter-linkages of the global economic system will ensure that the ripple effects will impact India – and its substantially weaker economy (when compared to 2008) no longer has the resilience to withstand the shock.
Ultimately, most problems boil down to Government finances and there is no choice but to address this on a war footing. India has a battle on its hand – of an economic nature – and the situation has to be dealt with accordingly. Anything less and we run the risk of a very serious slippage from where recovery will not only be hard, but also painstakingly slow.