Narendra Modi govt is mixing up its fiscal arithmetic; consequences may not be pleasant five years from now

When there is an election around the corner, everything gets big and loud: the stakes, the claims and the noise. The Union Budget for 2019-20 (FY20) was definitely big: Big on the government’s ambition for the next five years, big on some ideas for proposed reform, and big on claims of success achieved over the last five years. But big is not necessarily beautiful.

Here’s one thing that is big and not beautiful: interest payments—Rs 6,65,061 crore in FY20, according to Budget estimates. Looking back, they have been getting bigger and bigger every year, not just in Budget estimates but also when estimates are revised. For example, in the Budget estimates of FY19, interest payments were estimated at Rs 5,75,795 crore; the revised estimates made that Rs 5,87, 570 crore.

While government debt has been growing at a compounded annual growth rate (CAGR) of about roughly 4 percent over the 10 years, interest payments have been growing at a CAGR of nearly 12 percent. Set against the backdrop of some other numbers, that should also worrisome. Here’s why:

Interest payments are the single biggest item of expenditure in the Budget, accounting for about 25 percent of total expenditure – and over a third of total revenue receipts (think of that as income from taxes, basically). Interest payments are bigger than defence (Rs 3,05, 296 crore) and subsidies (Rs. 4,21,126 crore); in other words, interest payments account for nearly 92 percent of defence and all subsidies combined.

Here’s another comparison that should raise an eyebrow at least: interest payments plus loan repayments (Rs 2,36,878 crore in FY20) is 128 percent of the entire amount that the government will borrow (Rs 7,10,1000 crore) in FY20. The figure for FY19 is similar, based on revised estimates of the budget: 127 percent of the government’s gross borrowing of Rs 5,71,000 crore, and 119 percent for FY18.

Is the level of government debt sustainable? Two indicators suggest that it is: first, interest payments as a percentage of revenue receipts has sort of stabilised at roughly 34 percent over the last 10 years. Second, average interest cost (AIC) of government debt has been less than or about 7 percent in the last 5 years, lower than the growth rate of nominal GDP (around 11-12 percent in the last 5 years). But there’s more to India’s debt story than that.

In its annual status paper on public debt – a document produced by the finance ministry every year since 2010—shows that that share of market debt has risen to over 86 percent of total debt. This is part of a conscious government debt strategy; it also implies that government borrowing will be subject to interest rate risk. As long as the AIC is less than nominal GDP growth rates, that’s OK.

But our commitment to fiscal responsibility—which means that we commit to and keep the fiscal deficit at 3 percent of GDP – puts some limits on the amount that the government can borrow through its market borrowing programme. To maintain our fiscal sustainability, the total of interest payments and annual principal repayments should be as close to 100 percent of annual gross borrowing, which for the last three years, it hasn’t quite been.

In his Budget for FY17, Finance Minister Arun Jaitley introduced the idea of ‘extra-budgetary resources (EBR). The government would allow public sector agencies and public sector enterprises to raise debt on their books which will be used for social sector programmes; in August 2018, for example, the Union Cabinet approved raising these Rs 15,000 crore of EBR through NABARD.

This will be a 10-year bond used to finance the Swachh Bharat Mission (Gramin) programme to support the work of the National Centre for Drinking Water, Sanitation and Quality; the government says it will benefit 15 million rural households, and advance the goal of the Swachh Bharat Mission to make India open defecation free (ODF). The government will meet NABARD’s interest payments on this loan, and repay it in one bullet payment at the end of the 10th year.

NABARD is not the only agency; the Food Corporation of India (FCI) is another. In the medium-term fiscal policy statement—part of the documents that are released along with the Union Budget—the government says it had raised just over Rs 50,000 crore through such EBRs. You may recall that not too many years ago, the previous government created oil bonds as a way of meeting budgetary resources, outside the Budget itself.

This raises two important issues: One, the interest cost on these bonds will be higher than the AIC that the government is currently paying on its own borrowing. Bonds raised by public sector undertakings usually pay about 2 percent over the sovereign rate. That means the interest cost component in the annual Budget will go up, taking a bigger bite out of revenue receipts. It may not be large at this time, but could conceivably grow quite large if recourse to EBR rises.

Second, the impact on the balance sheets of the agencies themselves can be concerning, at the least. Another PSU is the Power Finance Corporation. Then, there are agencies, rather than PSUs like the India Renewable Energy Development Agency and Inland Waterways Authority of India. Their balance sheet status for market borrowing is a little unclear.

There is a third, perhaps subterranean question too: if the government resorts to the market for raising resources to meet social needs, what does that say about how, and to what purpose, will tax and other revenue resources are used? It opens up the possibility that political expediency and short-term considerations could play a larger role in how the government uses its annual Budget.

The cynical amongst us will argue that the government does that already; but social sector development – health and education spending mainly – need a sustainable resource base. The purpose of government spending is about providing finance for those areas that only the government can provide, and not leave them at the mercy of the market.

EBR is not innovative financing, as many would like to believe. It is a short-term fix at best, not a permanent one, many will argue. The trouble is, most government ‘solutions’ have a way of becoming permanent fixtures; that can be troubling at the very least for public finance, and frightening at worst. This kind of financing is not in anyone’s best interest.

(The writer is a former journalist, and communications consultant.)