The Comptroller and Auditor General of India (CAG) in its presentation to the 15th Finance Commission on July 8, three days after the Union budget, had questioned whether the fiscal deficit number is an accurate measure to be used to reflect government borrowing.
The report highlights the issue of fiscal transparency in the fiscal reporting of the Union and State Governments especially in the light of increasing trend of off-budget and extra-budgetary resource raising by the governments.
Before we delve into the issue at hand, some background to the case:
● What is fiscal deficit? Why is the number important?
Thus, Fiscal Deficit reflects the total borrowing requirements of Government. As far as India is concerned, we have had a history of running fiscal deficits as can be seen in the chart given below.
Is having fiscal deficit considered bad? Well, running fiscal deficits has been common for governments of developing countries as it is difficult for these governments to meet all the necessary expenditure for infrastructure, growth etc. only out of tax revenues. Hence fiscal deficits are not necessarily bad.
So what is the ideal fiscal deficit? In India, we have the Fiscal Responsibility and Budget Management or FRBM Act which suggested bringing the fiscal deficit down to about 3 percent of the GDP as the ideal target. Unfortunately, none of the governments have been able to achieve this target yet.
● What gives CAG the authority to challenge the fiscal deficit numbers?
Coming to the question as to why has the CAG proposed that the Central Government’s fiscal Deficit number should not be leaned upon. As per the CAG, the reasons are the following:
1.Increasing use of “off budget financing” to fund Capital Expenditure (Capex)
Let us have a look at the trend of IEBRs in the past budgets:
While the GBS movements gets captured in the fiscal numbers, the significant increase in IEBRs remains to be captured thus reducing the relevance of Fiscal Deficit in reflecting the borrowing of the government.
2.Use of “Off Budget Financing” to fund Revenue Expenditure: An accounting trick that governments across regimes have used recurrently is the postponement of committed expenditure on subsidies, particularly food subsidy to Food Corporation of India (FCI). Under the government’s cash accounting system, deferred payments are not considered as expenses. Thus the fiscal deficit number reduces on account of lower “cash“ expenditure, whereas the significant committed unpaid amount that is not considered in fiscal deficit calculation making the number deceiving!
As can be seen, the percentage of the subsidy paid against the expenditure incurred by FCI has been on a decline, which indicates that the unpaid bill of carryover liabilities seems to have become larger, rendering the FCI incapable of running its business without bailout loans from sources such as National Small Savings Fund (NSSF). (More on NSSF later in the article)
There is a similar case with the fertiliser subsidy where allocations in the budget are not sufficient to clear dues of past shortfalls and leading to increasing carryover liabilities.
3.Increased borrowing from the NSSF: The government has been increasingly dipping into the pool of small savings to fund its spending commitments. As highlighted above instead of allocating funds to public institutions from the budget, the government sanctions loans to public agencies like National Highway Authority of India (NHAI), Power Finance Corporation (PFC), Rural Electrification Corporation (REC), Indian Railway Finance Corporation (IRFC) and others from the NSSF so that it does not form a part of the fiscal deficit calculation.
It is important to note that the small savings rate is kept high to ensure adequate flows into small savings. Hence financing through NSSF comes at a high cost. (More on NSSF later in the article)
4.Capital Infusion into PSBs through Recapitalisation Bonds The ₹1.9-lakh crore of capital infused into Public Sector Banks (PSBs) in the last two fiscals has been done through the issue of recapitalisation bonds. These bonds don’t count under fiscal deficit calculation! (another ₹70,000 crore budgeted for the current fiscal). Sooner or later the interest and face value on these bonds will have to be repaid by the Centre.
Burdened with the need to accelerate growth through public capex amidst a shortfall in tax revenue and sticking to a fiscal glide path, the government had increasingly turned to extra-budgetary resources. This involves getting public sector enterprises or other such entities to borrow, with sovereign guarantee, to finance spending that should ideally have been funded from the Budget.
Going by the CAGs fiscal deficit calculation, taking into account these off budget sources, India is already in a deep fiscal hole, with the ‘adjusted’ fiscal deficit hovering near 5 percent of India’s gross domestic product (GDP)!!
What implications do these off budget sources of funding have on the overall economy?
As highlighted above, the government has been increasingly relying on the NSSF pool in order to fund its expenditure. The impact that this has on the economy as a whole is far-fetched.
Firstly, what is the NSSF? Small savings instruments comprise of postal deposits, Savings Certificates like National Savings Certificates or NSCs & Kisan Vikas Patras or KVPs and Social Security Schemes like PPFs and Senior Citizen Savings Schemes. The amount that household invest in these instruments forms the NSSF.
As illustrated, reliance of the government on NSSF funds hinders the process of monetary transmission, rendering policy rate cuts ineffective. Ineffective monetary transmission is one of the root causes of our ailing economy.
Also, when the government attracts more money from household savings towards the small savings fund by way of higher interest, the amount of these financial savings available for the private sector reduce, making it difficult for them to fund their borrowing requirements.
Way Forward – Will we be able to lean on the Central Government’s fiscal number?
The fact that the actual public sector borrowing remains much more than the fiscal deficit number, it fails to serve the purpose of using it as a measure of government borrowings. As per International standards and as per the amended FRBM Act, 2003, these off budget sources should form a part of the government’s debt calculation. There is an urgent need for making fiscal reporting more transparent and reliable. The most important and pressing reform that the government must take up promptly is the shift to accrual system of accounting to account for unpaid bills. Probably a separate council could be set up to ensure fiscal credibility and to prevent any such window dressing of numbers moving forward.