By the time you read this piece, you will have been bombarded with a huge amount of analysis on the Budget presented by the finance minister, Arun Jaitley, on February 29, 2016. But all the instant analysis that follows the Budget misses out on some of the bigger points.
While presenting the Budget last year, the finance minister, Jaitley, had set a fiscal-deficit target of 3.9 per cent of the gross domestic product (GDP).
Over the last few months many economists had suggested that Jaitley should abandon the fiscal-deficit target and increase public investment in order to revive the slow-growth economy. Jaitley had said in the recent past that he was receiving conflicting advice on what to do on the fiscal deficit.
He even referred to this in his Budget speech when he said: "Different schools of thought have argued in favour of either fiscal consolidation and stability or for a less aggressive consolidation and for boosting growth." Fiscal consolidation is essentially the reduction of fiscal deficit.
In the last Budget speech, Jaitley had set a fiscal deficit target of 3 per cent of the GDP by 2017-2018. Given that it was important that Jaitley continued to work towards this number, on the face of it, this seems to have happened.
The fiscal deficit number for 2015-2016 came in at 3.9 per cent of the GDP; and for 2016-2017, the target has been set at 3.5 per cent of the GDP.
Does this mean that the finance minister has abandoned public investment? Not really. A total ₹2.18 lakh crore has been allocated towards capital investment in roads and in railways. Nevertheless, at the same time he has said that the government will maintain a fiscal deficit of 3.5 per cent of the GDP.
The theory about increasing public investment goes somewhat like this: the industrial and consumer demand in the country are both growing at a slow pace. And given this, the government should step in spending more money and, in the process, hope to push up economic growth.
But there are multiple problems with this theory as there often are with any theory which is as simplistic as this one is. First and foremost, the Central Statistics Office (CSO) of the Ministry of Statistics and Programme Implementation has said that India will grow by 7.6 per cent in 2015-2016. The question is if the economy is growing at 7.6 per cent, then does it really need an extra 'dose' of public investment from the government? And if it does, does it mean that the government doesn't believe its own economic-growth numbers? Also, one needs to see the long-run impact of increase in public investment on the government budget. This can be seen by looking at the ratio obtained by dividing the revenue deficit by the fiscal deficit. Before I get into this, it is necessary to define these terms. Fiscal deficit is essentially the difference between what a government earns and what it spends. Revenue deficit, on the other hand, is the difference between revenue receipts and revenue expenditure of the government. Revenue receipts essentially refer to the money that the government earns through taxes and other sources like dividend income from the companies that it owns, profit made by the Reserve Bank of India and the interest income on the loans it has given out. Revenue expenditure, on the other hand, refers to the money the government spends on meeting its regular expenses like paying salaries and pensions; making interest payments on the money that it has borrowed; funding food, petroleum and fertiliser subsidies; and so on. The difference between revenue receipts and revenue expenditure is referred to as revenue deficit. If revenue deficit goes up, it basically means that the government is not earning enough to fund its regular expenditure. Over and above revenue receipts, the government also makes money by selling some of its assets (i.e., shares of companies that it owns), among other things. The money thus earned is referred to as capital receipts, and this, along with revenue receipts, makes up for the total income of the government. Along with incurring regular expenditure, the government also spends money on creating assets like roads and other physical infrastructure. This expenditure is referred to as capital expenditure. This along with revenue expenditure makes up for the total expenditure of the government. The difference between total income and total expenditure is fiscal deficit. Fiscal deficit is funded through borrowing. The government sells bonds in order to borrow. Also, revenue deficit is a part of fiscal deficit. Now let's take a look at the ratio of revenue deficit and fiscal deficit over the years. In 1971-72, the ratio stood at 5.7 per cent. The ratio has gone up since then. In 1981-82, the ratio was 24.5 per cent. In 1991-92, it was 44.8 per cent; in 2001-02, 71 per cent; in 2011-12, 76.4 per cent.
The ratio projected for 2015-2016 was 71 per cent. The revised number has come in as 63.8 per cent. And the projection for the next year is 66.3 per cent. This is a good trend which needs to continue.
What does this tell us? Revenue deficit has formed a greater portion of fiscal deficit over the last 45 years. It means that more and more government expenditure is directed towards meeting government's regular expenditure, which does not really create any assets which can be used over the long term, though this has been reversed in the recent past. How does this happen? The government increases public investment. This leads to faster economic growth. This means greater revenues for the government. This leads to a higher expenditure and this essentially pushes up government borrowing. As economist Rathin Roy wrote in a recent column in Business Standard, "Investment generates economic returns that ultimately allow the government to increase the size of its consumption expenditure." This means that a greater portion of the government expenditure goes towards meeting its regular expenditure. And this portion has gone up dramatically over the years. Hence, the short-term benefits of increasing public investment lead to other problems.
This essentially means that the government is spending lesser and lesser money on creating long-term assets. And this can't possibly be a good thing, given that these assets contribute to economic growth. What the increasing ratio of revenue deficit divided by fiscal deficit also tells us is that the government is borrowing more and more over the years in order to fund its regular revenue expenditure and that can't possibly be a good thing. At an individual level, this means using the credit card to meet regular monthly expenses like paying the rent, buying food, going out shopping, etc.
Any borrowing should work towards creating assets both human as well as physical. And this has clearly not happened for many years. Hope Jaitley and Narendra Modi are able to reverse this trend.
Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected].
This column appeared in the April 2016 Issue of Wealth Insight.
This article was originally published on May 06, 2016.
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