UPA's cupboard is bare even before the spending has begun

Empty coffers make the most noise. Last week we saw big headlines in the pink press announcing the clearance of BP’s $7.2-billion investment in Reliance Industries’ Krishna-Godavari offshore gasfields. We were also told that the Committee of Secretaries (CoS) had signalled green for foreign investment in multi-brand retailing.

These big-bang moves were partly driven by desperation, and the need to dispel negative public perceptions: that the government is paralysed on the economic reforms front, that the economic slowdown is worsening, that inflation is running out of control, and, above all, that there is little money in the till at a time when the National Advisory Council is planning big-ticket increases in expenditures on the food security front.

The flurry of activity has been necessitated by the realisation that the UPA’s political calculations may get overturned by its economic miscalculations.

The political calculations that have guided all of UPA’s actions so far are to ensure a clean majority for Rahul Gandhi by 2014. This means spending huge amounts of public money on social sector schemes in the name of the Gandhi family, and letting allies and the government of Manmohan Singh take the rap for any negative fallout.

The script for the remaining three years of UPA-2 runs parallel to UPA-1. This is to ratchet up public spending in the last two years (2012-2014), and using the current year - which is the midpoint of UPA-2 - to get the government’s finances in order before the final push.

However, the 2011-12 budget is unravelling and by next year the government’s finances could be in worse shape than this year. Here are the tell-tale signs:

First, the coffers are running low, thanks to high tax refunds and the slowdown in economic activity. In April-June 2011, tax refunds rose a whopping 205 percent over 2010, eating into the government’s collections. The tax department dished out Rs 46,868 crore in refunds this year compared to Rs 15,366 crore last year. Thus, even though gross direct tax collections were up 24 percent, net collections were down 17 percent.

Tax refunds tend to be high only when excess is paid or deducted in the early part of the year. This is a clear signal that in the second half of 2010-11 corporate and personal incomes were lower than anticipated earlier, when advances taxes were paid. It is a reconfirmation that the slowdown is for real.

Second, the government’s expenditures are outrunning incomes by a huge margin. This is why in just two months of 2011-12 (April and May), the government’s fiscal deficit - the gap between revenues and expenditure before borrowings - had consumed a third of the entire year’s estimate: Rs 1,30,726 crore against the entire year’s budgeted fiscal deficit of Rs 4,12,817 crore.

Third, the government is simply unable to pay its bills on time. According to a Hindustan Times report, the Food Corporation of India (FCI) twice defaulted on payments to state governments and grain procurement agencies because the government had not made the cash available. The FCI wants Rs 38,000 crore to continue procuring grain from farmers. “There is no money for August and September,” the newspaper quoted a government source as saying.

Fourth, thanks to raging inflation, the government scored a self-goal when it raised cooking gas, kerosene and diesel prices in June while simultaneously reducing duties. It thus transferred a part of the losses of oil companies on to its own books. It took a revenue hit of Rs 49,000 crore when it could ill-afford it. But despite this, the oil companies will probably be seeking over Rs 1,20,000 crore more in subsidies if oil prices remain where they are for the rest of 2011-12. If they rise, god help Pranab Mukherjee.

[caption id=“attachment_48084” align=“alignleft” width=“380” caption=“The government’s expenditures are outrunning incomes by a huge margin, which is why the fiscal deficit for May and April had consumed a third of the entire year’s estimate: Rs 1,30,726 crore. Reuters”] [/caption]

Fifth, since the show must go on, with or without money in the pocket, the government is upping its borrowings. It recently shocked the money markets by advancing a Rs 10,000 crore loan auction scheduled for 19 September to 13 August. The government has already breached its short-term Rs 30,000 crore borrowing limits with the Reserve Bank (called ways and means advances) by running up borrowings of Rs 39,000 crore on 15 July.

Sixth, Mukherjee is busy scrounging around from money by selling more of the household silver. The finance ministry has been badgering the Department of Telecom (DoT) for more spectrum auctions to raise money for the exchequer. Though there is little chance of a bonanza like last year’s - Rs 1,06,000 crore was earned (and blown up) in a jiffy by selling 3G and broadband wireless spectrum in July last year - it is pressing DoT for another round of auctions to raise around Rs 13,000 crore. It’s a drop in the bucket, but then it’s a drop that the government currently does not have.

So, this is the state of government’s finances even before we have reached the half-way mark in 2011-12, when the big political spending hasn’t even begun with the launch of the Food Security Bill (FSB), which could cost Rs 1,00,000 crore every year. One wonders how the government is going to find the resources for 2012-13 and 2013-14, when the spending will have to be stepped up in the run-up to the 2014 general elections. It is this reality that emboldened the government to whittle down NAC’s Food Bill to the bone, but it’s still not enough.

High spending, both on the National Rural Employment Guarantee Act (NREGA) and farm loan waivers, was critical to the UPA’s 2009 election victory. But two things happened around that time that up-ended its economic calculations.

One was the global economic recession of 2008-09, and the drought. Due to this, government’s finances went for a toss, and inflation roared back to double-digits on the back of the huge fiscal stimulus (that is still to be wound down).

But the second, and more important, push to inflation came from the government’s own political calculations. In order to woo the farm vote in 2009, the UPA kept minimum support prices (MSP) down in its initial years before suddenly letting it rip in 2008-09.

MSP increases averaged just 4-5 percent between the last years of the NDA and the first four years of the UPA (2002-08), but in 2008-09, MSP went up by a whopping 30-70 per cent for various kinds of food grains and pulses, according to an analysis by V Kumaraswamy in Business Standard.

Little wonder, farmers were committing suicides earlier, and gratefully voted for the UPA after the 2008-09 manna from heaven.

But what was dessert for farmers was poison for urban consumers - who saw inflation destroy their earnings. The UPA’s was trying to be too clever by half, and resulted in a long-term inflation nightmare. Assuming the Food Security Bill (FSB) is enacted, and the UPA continues with its strategy of wooing farmers closer to the election date (it may anyway have to, in order to procure 60 million tonnes annually to feed the FSB), there is little possibility of inflation receding anytime soon. And we are assuming there is no major monsoon failure till 2014.

Here’s the UPA’s ultimate dilemma: if it raises food prices to run its FSB and procure more grain, it will inevitably boost inflation. If it does not do that, farmers will be upset, because their costs have been soaring along with wages and other inputs. If the food procurement falls short of the FSB’s needs, grain will need to be imported at costs that are much higher than Indian levels.

This means by 2014, the country will not only be paying huge oil bills, but also food bills.

Meanwhile, the Union budget will be sadly out of shape on the fiscal deficit front. The only way to plug the gap will be to sell more state assets - not just spectrum, but public sector shares. This needs the market to start looking up.

This is where the need to open up the economy to foreign direct investment (FDI) makes eminent sense. You need the moolah - whether it is to import oil and foodgrain or to give the domestic stock market a dose of steroids.

The UPA is trying to square the circle of economic miscalculation by hastening up FDI reforms in the hope that everything falls into place. It is a gamble.