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Mainstream, VOL LVIII No 1 New Delhi December 21, 2019 | ANNUAL NUMBER

India’s Looming Financial Crisis, Mounting Expenditure and Exploding Debt

Saturday 21 December 2019, by B P Mathur

Kautilya, the 3rd century BC philosopher-statesman, had observed that ‘a king with depleted Treasury eats into the very vitality of citizens and the country’. The Indian Government’s Treasury today is empty due to years of profligacy by the government, its revenues falling short of ever-increasing expenditure and the shortfall met by recourse to debt. But debt has to be paid back and unless prudently used, imposes heavy future burden on the debtor, be it individual, corporate or government. Through-out history incurring debt was considered ominous. The interest payment on debt was regarded as an onerous burden on the poor and seen as an unjustified reward for the capital. To the Christian, the idea of usury was equated with sin. Jesus Christ had famously said, ‘The rich rule over the poor and the borrower is the slave of lender.’ Islam forbids debt altogether. Shakespeare’s famous play, TheMerchant of Venice, graphically portrays how the lender extracts his pound of flesh from the borrower.

The industrial revolution and the emergence of the modern state, however, changed the ancient concept of debt, and lending money through a well-functioning banking system was not only considered legitimate but necessary for investment of capital and sustained economic growth. In the past sovereign governments borrowed mainly during war and peace-time borrowing was rare. However, Keynesian economics, which helped successfully fighting the great depression of the 1930s, entrenched the idea in management of public finance that sovereign states can borrow money through budgetary deficits, which will help development and growth of the economy.

All borrowings have their limits and reckless borrowing can create a financial crisis as was the case with the global economic meltdown of 2007-08. High growth in the US and other Western countries was driven by easy avai-lability of cheap credit by over-indulgent banks, which recklessly extended loans and practised dubious financial engineering, which ultimately triggered a widespread debt default. This policy to a large extent was the result of the Central Bank’s populist measure of promoting cheap credit and deregulating the banking sector. The Bill had to be ultimately picked up by the government. In the USA, General Motors and housing finance giants Fannie Mae and Freddie May were practically nationalised with the govern-ment pouring billions of dollars in them, to save them from collapse and stimulate demand. A financial expert noted in Newsweek (Special Edition 2011), ‘Never outside periods of total war, has the debt of the world’s most powerful states grown so immense. Never has it so heavily threatened their political systems and standards of living. Public debt cannot keep growing without threatening terrible catastrophe.’

It needs to be underlined that all the economies of the developed countries sustain their growth rate and high standard of living by resorting to heavy dosage of debt-household debt, corporate debt and government debt. The huge expansion of household debt is largely due to the West’s materialist and consumerist culture which has made them into ‘buy now and pay later’ credit card societies. At the peak of the financial crisis of 2007-2008, household debt reached an unsustainable level of 100 per cent of the GDP in the USA, 130 per cent in Spain and 160 per cent in Britain. It has now come down and presently (2018) stands at 86 per cent of the GDP in the UK, 78 per cent in the USA, 58 per cent in France, 57 per cent in Japan and 53 per cent in Germany. In India household debt is only around 11 per cent of the GDP, although consumer goods companies are making their best effort to spread Western-style consumerism by offering cheap credit and other allurements. Fortunately in India, due to people’s belief in traditional values of thrift and ‘living within one’s means’ attitude, household debt poses no threat to the stability of the economy. However, there are serious problems with corporate debt. The percentage of bad loans- NPAs (non-performing assets) of 16 Public Sector Banks, is as high as 10 per cent of all loans advanced. In case some banks’ bad loans are more than 20 per cent, this poses the threat of their going bankrupt. In order to restore their financial health, the government has to perforce recapitalise them and pour huge money from its budgetary resources.

Mounting Public Expenditure

Post-independence India has launched a large number of schemes for the economic and social development of the country and spending huge money. They have, however, not yielded the desired outcome due to various inefficiencies such as poor implementation, bad designing, bureaucratic apathy and corruption. The country could not therefore attain faster economic growth and the desired level of prosperity. This results in very low tax yield— the main source of a state’s revenue and the government is perennially dependent on borrowing for its multifarious needs. From the time the Congress lost its pre-eminent position in national politics, every government, when it comes to power, has been launching populist schemes with no economic rationale, with the sole intention to influence the voters during the elections. This has thrown the finances of both Central and State governments out of gear.

In more recent years, the problem of budgetary deficit became acute, when the UPA-I Government in its last year in office, threw away fiscal caution and substantially increased expenditure, as well as borrowing with an eye on the election scheduled in May 2009. In the year 2007-08 borrowing constituted 18 per cent of the total expenditure, with over 90 per cent earmarked for capital expenditure. However, in the Revised Estimates 2008-09 presented to Parliament in December 2008, the UPA Government, jacked up expenditure by 20 per cent over the Budget estimates (BE), almost all of which was financed by borrowing. Thus overall 38 per cent of expenditure was financed by borrowing, the bulk of which was consumption expenditure, with capital expenditure only 27 per cent of borrowed funds. The government’s ostensive reason was to revive the economy by giving tax sops and other concessions in the wake of global recession, although India was not severely impacted by the West’s economic downturn. The government also introduced populist schemes such as the NREGA and debt remission of farmers, apparently with an eye on the election which was slated in May 2009. During the five-year tenure of UPA-II (2009-14), borrowing constituted on an average 35 per cent of the total expenditure and out of borrowed funds only one-third (34 per cent) was utilised for capital expenditure. The NDA Government, which came to power in mid-2014, has continued the same policy of heavy borrowings, the bulk of which are being used for consumption expenditure. During the five-year tenure of NDA-I (2014-19), borrowing accounted for 30 per cent of the total expenditure and out of borrowed funds 45 to 50 per cent has been classified as capital expenditure. However, there is a catch in the higher classification of the capital outlay. Since 2016, the government has been treating the entire component of grant given to State governments, autonomous bodies and local government, as ‘grant for capital expenditure’ though some portion of expenditure under schemes such as MGNREGS, MPLAD, PMAY etc. is revenue expenditure. The capital expenditure component of expenditure is obviously being overstated. (CAG, Report on FRBM Act, No 20 of 2018) Table 1 gives the full details of Central government expenditure, borrowing, capital expenditure for the last 12 years.

Table 1 : Expenditure & Borrowing of Government

Source: Government of India, Budget, Various year.

From the above table it may be seen that currently out of every rupee that the government spends 25 to 30 paisa comes out of borrowed funds and out of borrowed funds only 35 paisa, which has arisen to around 45- 50 paisa (with questionable accounting classification) is spent on capital works. It is the first principle of public finance that borrowed funds should be spent on creation of capital assets so that a future stream of income is generated which would help paying the interest burden. Borrowing money and spending it on current consumption can have disastrous consequences for the economy as we are witnessing today.

Debt Burden

The Central Government’s total debt at the end of March 2019 was Rs 90, 56, 700 cr. The Internal debt includes loans raised from the market, including borrowing through the Treasury Bill, Small Savings and Provident Fund. In addition, States also borrow for their various needs. The combined debt of Central and State governments at the end of March 2018 was Rs 1,14,47,000 cr which is around 68 per cent of the GDP. The FRMB Review Committee (2017) had suggested that prudent level of debt should not exceed 60 per cent of the GDP—40 per cent for the Central Government and 20 per cent for States. The Central debt for the last few years has been around 46-47 per cent of the GDP (by some calculation 49 to 50 per cent of the GDP).

Years of deficit budgets have led to a situation where almost 35 per cent of Central Government revenue go away as interest cost of servicing the debt. In addition, the government has to return some principal which matures every year. The servicing component of debt was 77 per cent of borrowing in 2015-16 and 74 per cent in 2013-14 and thus a large part of the borrowing is simply used to pay past debt, and very little is left for fresh investment. (CAG’s Report on Public Debt Management No 16 of 2016) Due to past profligacy the government of the day finds itself in a real bind—almost 75 per cent of its borrowing for the year go away to service past debt and 35 per cent of its revenue receipts have to be paid as interest charges.
Table II gives the position.

External Borrowing

India has been in the past recipient of large external assisatnce, often termed as foreign aid, from multilateral sources such as the World Bank, ADB, UNDP and bilateral sources such as Japan, Germany and other countries. During the 2nd to 5th Five Year Plans external assisatnce accounted for as high as 20 to 30 per cent of the gross budgetary support, as the country was critically short of financial resources as well as foreign exchange. Lately, however, India’s dependence on foreign assistance has greatly reduced as the international capital market is open for borrowing both by the public sector undertakings as well as the private sector. External Debt, as on March 2019, was Rs 2,59,000 cr at original book value, which is 6 per cent of the total borrowing (as per the RBI, the Multilatral debt on government account was Rs 3,20,300 cr and Bilateral debt Rs 1,41,300 cr altogether 6,61,600 cr, as on March 2019 at the curent rate of exchange). Most of foreign loans have low interest rate with long maturity period, but have to be paid back in foreign currency, against a declining value of rupee, and impose a heavy burden in the long run. Today external borrowing is imposing a negtive burden, as servicing cost is more than the fresh loan contracted. Table III below illustrates.

Table 2 : Interest Payment as Percentage of Revenue

External Borrowing

The history of the last two centuries show that many developing countries faced severe crisis as they were unable to pay debt contracted from rich capitalist countries and had to agree to harsh terms imposed by them. Left economist Eric Toussaint observes that in many cases major capitalist countries have taken over direct control of indebted independent states or else imposed conditions that have resulted in their subordination and weakening. In recent past, heavy foreign borrowings had disastrous consequences for some countries in Latin America and sub-Sahara Africa, and their economies virtually collapsed, as they were unable to pay back debt to their foreign creditors and had to agree to very onerous terms for the bail-out.

India’s external borrowing today represents a typical case of debt trap, wherein servicing cost is more than the fresh loan contracted. However, since the volume of public external debt has not been very high, the country can conveniently manage its servicing cost.

Reigning Deficit-FRBM Act

The government wasincurring a huge deficit in its Budget during the 1980s and 1990s and the combined fiscal deficit of the Centre and States was as high as 9 to 10 per cent of the GDP. The government appointed a Committee called Fiscal Responsibility Legislation (2000) under the chairmanship of E.A.S. Sarma, the then Secretary, Ministry of Finance, to suggest measures to control it. The Committee recommended that a legslation be enacted to progressivly reduce the deficit and in five years’ time—the revenue deficit be completely eliminated and fiscal deficit be no more than three per cent of the GDP with a ceiling of 50 per cent of the overall debt liability of the government. The report was refered to the Standing Committee of the Minstry of Finance, which watered down the recommen-dations and suggested that the target of reduction of Revenue and Fiscal Deficit be shifted to ‘Rules’ framed under the Act, to give the government flexiblity in meeting its expenditure commitment. Accordingly a Fiscal Responsibility and Budget Management Act was enacted in 2004. While for the first few years of enactment of the FRMB Act, fiscal discipline was being followed, from 2008-09 onwards the government started incurring huge deficits. In 2007-08 the Centre’s fiscal deficit was 2.54 and States 1.52 althgether four per cent of the GDP. But in 2008-09 it jumped to 5.99 for the Centre and 2.26 for the States, altogether 8.17 per cent of the GDP. The same trend of large budgetary deficit has continued year after year. In 2016-17, the Centre’s fiscal deficit was 3.94 per cent and States’ 3.65 per cent altogether 7.57 per cent of the GDP.

Table III: External Loan & Repayment 

- Rs cr  2017-18  2018-19   2019-20 BE
1 External Loan 38,200   27,700   33,400
2 Repayment of Loan  26,700 31,300    35,400
3 Net Assistance (1-2)    11,500    —3,600    —1900
4  Interest  —6,000   —7900 —9800
Net External Assistance (3+4)   5600 —11500   ---11700

               Source: Budget 2019-20

In order to have more fiscal space, the government appointed another committee, called FRMB Review Committee, headed by N.K. Singh, a former civil servant, to review the debt and fiscal targets. The committtee (January 2017) reiterated the need for fiscal discipline and emphasised rule-based discipline in managing national fiannces. It recommended that Fiscal Deficit be progressively brought down to 2.5 per cent and Revenue Deficit to 0.8 per cent of the GDP by 2022-23. It also recommended that there should be a ceiling of debt/liability of 60 per cent of the GDP—Centre at 40 per cent and States at 20 per cent. Subsequently the government amended the FRMB Act through the Finance Act of 2018, making Fiscal Deficit , the only operational target to be achieved, at 3 per cent of the GDP by March 2021. The rules also envisaged a debt ceiling of 40 per cent of the GDP and overall (including States) at 60 per cent of the GDP.

There is no visible sign that the government is in a mood to control deficits and achieve the targets indicated in the amended FRMB Act. The Centre’s fiscal deficit was 3.5 per cent of the GDP in 2017-18, 3.4 per cent in 2018-19 and projected at 3.3 per cent for 2019-20. A more alarming feature is the huge revenue deficit, which was 2.6 per cent of the GDP in 2017-18 and 2.2 per cent in 2018-19. The government is doing some accounting trick to show lower deficit. The CAG has pointed out that the government is deferring payment of subsidy to fertiliser companies, Food Corporation and Accelerated Irrigation programme and to solve their liquidity problem making special banking arrangement (on which interest is paid) and showing them as off-budget expenditure, though they are revenue expenditure for the relevant year (CAG Report on FRMB Act, No 20, 2018).

Under the current globally accepted practice, deficit is depicted as percentage of the GDP, but it hides the real extent of the problem. In pure money terms in 2018-19 the government’s revenue was short by Rs 6,34,400 cr, that is, 25 per cent to meet its overall expenditure (revenue + capital). Further to meet its current consumption, it incurred Rs 4,10,900 cr, that is, 24 per cent more than the total revenue it earned in the year.


Economists’ Culpability 

Large budgetary deficits are justified as a result of Keynesian prescription to deal with an economy in recession with large unutilised capacity. Subsequently an influential section of economists have been supporting large budgetary deficits, so that more public spending can be done, as it would accelerate economic growth. Questioning such logic economist Martin Feldstein observes: “It is unfortunate therefore that, starting with 1940s, economists developed a series of different arguments that encouraged the political process to accept larger and larger peace time deficit. These analyses started with simple Keynesian arguments and were followed by new theories of economic growth, theories of household savings behaviour and models of global capital markets. The arguments were intellectually quite diferent from each other but they lead to the same conclusion: budget deficit in peace time were not a problem.” (Budget Deficit and National Debt: RBI, L.K. Jha Memorial Lecture, January 2004, available at accessed on November 1, 2019)

It needs to be realised that budgetary deficits impose huge burden on the economy. Since they are not visible they are popular with the politicians. Deficits shift the fiscal cost to future generation and raise fundamental issues of inter-generational equity. Budget deficits have severe adverse effect on capital accumulation, economic growth and future tax rate, which may lead to financial crisis. Continous deficts in Budget may also lead to uncontrolled inflation. Large deficits year after year will finally lead to debt trap where servicing of past debt will be more than debt contracted and land a country into bankruptcy.

A fundamental rule of public finance is that government’s the revenue should exceed the govern-ment’s non-interest outlay. The excess of revenue over expenditure should be sufficient to finance interest payment on public debt. There is no sound logic to link budgetary deficit with the GDP—it should be corelated with government revenue. The GDP is basically an estimate of the value of a country’s goods and services, which have been monetised, and is a ‘guesstimate’, its numbers varying widely depending on the method used to estimate income and wealth of the country. Linking budgetary deficit with the GDP camouflages the real picture of a nation’s finances.

I have worked in the Finance Divison of several Ministries of the Government of India and have handled financial management of several large Public Sector Undertakings and have been actively associated with the government’s budgeting exercise—its preparation, approval, monitoring and implementation. A correlation between income and expenditure is fundamental to sound finance. In personal finance, corporate finance, or finances of any organisation/entity there has to be invariably a corelation between expenditure and income and limit expenditure accordingly. Why should not the same principle apply in respect of government finance?

Economists make an error when they do not measure deficit in terms of ‘revenue’ garnered by an economy and instead measure in terms of the GDP percentage. Thus they play into the hands of the ‘smart politician’, who use such intellectual support to go on spending spree, to advance their political agenda, without resorting to unpopular route of raising resources through taxation. Therefore the proper rule should be that in a particular year, government expenditure should not be more than a certain percentage of its revenue, more particularly tax revenue, that is, say in a year, the total expenditure (both captal and revenue) should not exceed 10 per cent of tax revenue for the year.

Table IV A : (merge table IV A & B)

Tax Revenue % Government Expenditure

Table IV B: Tax Revenue % Government Expenditure (Continued)

Note: For expenditure see Table 1


India’s Soft Tax Regime

It is through taxes, direct and indirect, that public expenditure is financed. While expenditure is growing exponentially every year, there is no commensurate growth in tax revenue. Tax revenue finances only around 50 to 60 per cent of public expenditure, which is a cause for serious concern. Table IV depict the position from 2007-08 onwards.

The tax revenue of the government—Central and States—is currently 17 to 18 per cent of the GDP, Central Government 10 to 11 per cent of the GDP, and States 6 to 7 per cent of the GDP. In OECD countries tax collection as percentage of the GDP is 34 per cent. Tax to GDP ratio is 46 per cent in France and Denmark, 37 per cent in Germany, 36 per cent in Norway, 33 per cent in the UK and 27 per cent in the USA. (OECD: Revenue Statistics) With such low tax collection it is wishfull thinking that India can provide essential welfare services to its vast population.

India has a very soft tax regime for personal Income tax. Substantial tax exemptions are being given to a large body of ordinary Income tax payers. The maximum Income Tax rate is 30 per cent with 4 per cent surcharge. However, for the super-rich there is surcharge 15 per cent, which in current year’s Budget 2019-20 has been raised to 25 per cent for incomes between Rs 2 to 5 cr and 37 per cent for above Rs 5 cr, making the effective tax rate 39 per cent and 42.7 per cent for these two categories. There was a huge hue and cry when the government raised tax rates for the super-rich in the latest Budget. It should be noted that the highest marginal Income Tax rate in India is still less than most advanced countries known for friendly tax regimes. Top marginal personal tax rate is 60 per cent in Sweden, 56 per cent in Denmark, 55 per cent in France, 47 per cent in Germany, 45 per cent in UK and 43 per cent in USA. According to Forbes, India has today more than 3.43 lakh dollar millionaires (2018). Shouldn’t they pay substan-tially more taxes?

Businesses are largely organised as a company under the Indian Companies Act. There are about 3,90,700 comapanies registered under the Companies Act. Out of them 46 per cent companies reported profit, 43 per cent loss and 11 per cent as no profit (2017-18). The statutory rate of tax for the Companies ranged between 31 to 35 per cent of profit, depending on income turnover. However, the effective tax rate of companies reporting profit was 29.4 per cent. Total corporation tax collection during 2018-19 was Rs 6,71,000 crs and budgeted at Rs 7,66,000 crs for 2019-20. In the wake of the economic slow-down, the Finance Minster has made drastic reduction in the rates of corporation tax in September 2019. The justification given is that it would encourage more investment. The effective rate has become 25.17 per cent inclusive of cess and surcharges. This will result in a huge revenue loss of Rs 1,45,000 cr. How is the government going to meet this loss is a big question.

In case of indirect taxes, most notably Customs and excise, a large number of tax preferences have been given by way of special tax rates, exemptions, deductions, rebates, deferrals and credits. As a result of liberalisation, duty on most imported products has been substantially lowered—for examples, duty on electronic goods is nil and on edible oil and gold very low. This not only reduces customs revenue but also has widespread impact on the economy. Cheap imports of electronic goods prevents development of indigenous electronic industry and of edible oil adversely effects viability of domestic oilseed crops such as groundnut, mustard and til.

Every year in the Budget document, details are given of the ‘Revenue Impact of various Tax Incentives’ which implies loss of revenue due to current tariff as compared to statutory rates. For example, ‘Revenue Impact of Tax Incentive’ for 2017-18 and 2018-19 for some taxes was estimated as follows: Corporate Tax Rs 93,600 cr and Rs 1,08,800 cr and for Individual/ HUF Rs 83,800 and Rs 97,300 cr. In case of Customs, in many cases the applicable duty is less than the prescribed Basic Customs Duty and concessions are also given due to Free Trade Agreements and Export-related Incentives etc. which result in lower collection of taxes. There is need to suitably calibrate tax incentives, so that the governments revenue interest is safe-guarded.

The government has taken an important step of tax reform with the introduction of Goods and Services Tax. However, there exist major problems due to large black economy and corruption, which severely impacts tax collec-tion. Raising revenue by better tax compliance, rationalising tax structure and curbing the menace of black money are some of the major challenges before the government.

Disinvestment—Selling the Family Silver

Desperate for revenue, the government has been selling shares of profitable PSUs (Public Sector Undertakings), without any economic rationale. Public Enterprises were the edifice on which India’s development strategy was built. However, post-economic liberalisation theIndian policy-makers are pursuing a policy of privatisation and dismantling of state-enterprises, eroding the industrial base of the country, built assiduously over years. The governments, both of the UPA and NDA, have been divesting portfolios of profitable companies,while retaining majority control, so that their status as government company remains. There is no sound economic logic to sell shares of profitable PSUs in the core sector of the economy. The government has been earning huge money by disinvestment—Rs 43,100 cr in 2015-16 and       Rs 47,700 cr in 2016-17, Rs 1,00,045 cr in 2017-18, Rs 80,000 cr in 2018-19 and budgeted for Rs 1,05,000 cr for 2019-20. This money has been used to meet the government’s burgeoning budgetary deficit and violates all canons of prudent fiscal management. The present policy tantamounts to selling the family silver to pay for the grocers’ bill.

It may be mentioned that PSUs on the whole are making substantial contribution to the national exchequer by way of dividends—Rs 30,600 cr in 2015-16 and Rs 51,900 cr in 2016-17, Rs 46,500 cr in 2017-18, Rs 45,100 cr in 2018-19 and budgeted for Rs 57,500 cr for 2019-20. Selling them would eventually dry up the steady income from them and tantamounts to killing the goose that lays the golden egg.

PSUs as a group are, however, are a mixed bag. While many are in core and strategic sectors, running profitably, a good number are sick and chronically loss-making and a big drain on the economy. Sick industries should have been be the first candidates for privatisa-tion but the government is unable to do so and carrying their burden. The present policy can be described asprivatisation of profit and nationalisation of losses. 

Dividends and surplus from the RBI, banks and financial institutions are making substantial contribution to the government kitty. It was Rs 91,400 in 2017-18 , Rs 1,19,300 cr in 2018-19 and budgeted for Rs 1,63,00 for Rs 2019-20. In August 2019, the government virtually forced the RBI to transfer a surplus of Rs 1,76,000 cr to its kitty. The decision was controversial as it would reduce the RBIs risk provisioning, critical for the Central banker and was being opposed by several past Governors of the RBI.

Public Sector Banks—In Deep Crisis

The government can garner higher tax revenue if the economy is robust and growing at the sound rate of growth. A sound banking system plays an important role in productive invest-ment and creation of wealth. Public Sector Banks, who dominate the banking sector in India, are facing severe crisis. They are saddled with huge NPAs (Non-Performing Assets) largely due to indiscriminate advances given in the past, due to a number of reasons such as mismanagement, corruption and political meddling. In order to improve their health, so that they develop capability to advance credit and follow capital adequacy norms prescribed by Basel/RBI, the government has injected huge amount of money into them. Between 2008-09 to 2016-17 the government has infused Rs 1,18,700 cr for recapitalisation of the PSBs. In 2017-18 a further sum of Rs 10,000 cr was infused for their recapitalisation, besides Gross Budgetary Support of Rs 80,00 cr which was met by the issue of Special Security Bonds. Similar gross budgetary support through Special Security Bond of the order of Rs 1,06,000 cr was made in FY 2018-19 and is budgeted for Rs 80,000 cr for 2019-20. The issue of Bonds adds to the government’s long-term debt liability, though it reduces current year’s budgetary deficit and is simply an accounting trick to depict a low fiscal deficit. Public sector Banks have been writing off huge amounts to make their balance-sheet look clean. Between April 2014 to April 2018, a sum of Rs 3,16,500 cr of 21 PSBs was written off. During this period a recovery of Rs 44,900 cr, written off earlier on a cumulative basis, was made. Total bad debts written off from 2001 to 2018 are reported to be of the order of Rs 4,97,000 cr. In banking parlance these are technically accounting entries and not loan write-off. Banks pursue recovery of loan through Bankruptcy Courts and other means and some portion of the ‘loan write-off’ is recovered. The huge NPA and bad debts show a deep malaise in the corporate sector. Some of the largest companies are facing dissolution under the Indian bankruptcy code. The distress is acute in some sectors like power, metal and telecommu-nication. Widespread distress in the corporate sector has larger ramification and threatens an economic meltdown of the economy.

Mounting Employees Cost

One of the biggest components responsible for the huge deficit in the Budget is, expenditure on emoluments and pension of public servants. The 6th Pay Commission gave a huge bounty to government employees, not only increased their basic pay substantially but indexed salary to inflation, and every six months the employees get a salary hike based on rise in the cost of living. Several other benefits were also given, such as increase in house rent allowance, travel by air on LTC for certain category of employees, women employees eligible for two-year leave on full salary to rear children. Since pension is linked to the grade from which a public servant retires, pensioners automatically get the benefit of salary hike of working employees. Pensioners were also given new perks—one could retire on full pension after 20 years of service instead of the earlier 33 years; an escalation of pension by 20 per cent every five year on attaining the age of 80. The overall financial cost to the government is given in Table V. (The Report of 6th Pay Commission was submitted in March 2008 and accepted in August 2008, effective from 1st January 2006. The arrears were paid spreading over two years. Therefore its impact was felt in FY 2008-09 and 2019-10 onward.) These benefits resulted in a hike on expenditure on pay and pension from around 20 to 21 per cent of the Central Government’s Tax Revenue to around 37 to 38 per cent—thus an additional 15 per cent of revenue had to be earmarked for payment of wages and pension of public servants.

Table V: Wages & Pension of Civil & Defence Employees as Percentage per cent of Tax Revenue

Note: (1) In the Budget, pension payment of Railway and Post are shown under their respective Ministry’s expenditure, as they are treated as commercial departments. Pension liability other than Defence are shown under separate Demand of Grants under Ministry of Finance. Pension Civil in the Table includes Railway and Post. In 2018-19 Civilian Pension was Civil Rs 47,400, Railway Rs 48,000, Post Rs 14,600, that is, Rs 1,12,000.

(2) There are 36.20 lakh Central Government employees as in March 2019 (which include 13.70 lakh Railways and 4.20 lakh Postal). The armed forces strength is around 14 lakh.

 In the last decade, there have not been any substantive addition of civilian employees, their current strength—in March 2019 is around 36 lakhs, while in March 2015 was 33 lakh. The huge rise in emoluments bill is largely due to the pay hike of the existing employees and not due to new addition, though there is great shortage of certain category of employees such as doctors, nurses, teachers and police constables.

It may be noted that in addition to salary and allowances, government employees are entitled to several perks like free medical treatment under the CGHS (only on nominal payment), subsidised housing, staff car, free ration to defence personnel posted at peace stations, which all add up to cost for the government.

A salary rise in the government has a cascading effect on the Central autonomous bodies and grant-in-aid institutions which are fully or partially funded by the government, as they follow the same pay scale and perks as the government. Demand for pay hike also comes from University teachers, and the government is obliged to set up another commission, which while proposing salary hike links it to the Central pay-scale. Due to competitive politics most State Governments try to adopt the Central Government pay scale for the States employees or have some kind of linkage with it. They are therefore forced to give salary hike to their employees, irrespective of the fact whether their finances permit it. Such pay hike has a disastrous effect on State finances. In some States like Assam, Bihar, Orissa, West Bengal and UP, employees emoluments may swallow bulk of the tax revenue generated by the State (on its own effort).

The governments-in-power, ever willing to please their employees, appoint a Pay Commission every ten years to review their emoluments. The 7th Pay Commission, whose recommendations came into effect from January 2016, gave another bonanza to its employees. It merged DA (Dearness Allowance) with salary and gave big jump in basic pay scales, keeping intact the earlier formula of periodically hiking DA linked to cost of living index. This resulted in additional liability of 2 to 3 per cent of tax revenue earned by the government. Thus presently around 40 per cent of Central Government’s tax-revenue goes to meet the employees’ emolument cost. Data on cost of emoluments of employees of the Central Government autonomous bodies, grant-in-aid institutions, Universities and school teachers etc. which is borne by the government, is not available. But as a ‘guesstimate’ their cost together with the wage bill and perks of direct government employees could run from 50 to 60 per cent of the government’s total tax revenue. Given the precarious finances of the government there is need for strict austerity measures. As economy measure the government needs to consider freezing DA (Dearness Allowance), withdraw facilities such as LTC (leave travel concession) and enhanced pension to retirees above the age of 80 and some other avoidable benefits. Employees should also share a reasonable portion of the cost of medical treatment under CGHS—presently they get free treatment, howsoever expensive, without any cap. 

Poor Outcome of Public Expenditure 

India today faces a formidable challenge in social and economic upliftment of its people. For the last sixty years, from the time we launched Five Year Plans, every government has launched numerous schemes in the area of poverty alleviation, agriculture, rural development, education and health but they have not been able to bring substantive improvement in the life of the people. This is largely because of poor productivity of public expenditure. Most of these schemes, known as Centrally Sponsored Schemes, are designed and funded by the Central Government, but are implemented by the States, with a defined share contribution. There were 66 CSS, which in 2016 were rationalised into 28 Umbrella schemes. At present over Rs 3,00,000 cr is being spent annually on these schemes (2018-19). The expenditure on some major schemes in 2018-19 is: MGNREGA Rs 61,000 cr, PM Awas Yojna, Rs 26,000 cr, PM Gramin Sarak Yojna, Rs 16,000 cr, National Health Mission, Rs 31,000, National Education Mission which includes Sarva Shiksha Abhiyan Rs 32,000 cr, Midday meal scheme Rs 9,900 cr, Integrated Child Development Rs 23,300. In addition vast sum of money is spent under Central pro-grammes such as: subsidy to Food Corporation of India for procurement and distribution of foodgrains, Rs 1,40,000 cr, subsidy for fertiliser supplied to farmers Rs 70,000 cr, National Highway Authority Rs 41,000, Road Cons-truction Rs 37,300 cr and newly introduced schemes such as Smart City and Urban Rejuvenation Mission Rs 12,600 cr and crop insurance for farmers Rs 13,000 cr.

The performance audit conducted by the CAG, social audit conducted by NGOs and studies by experts show there is huge wastage and leakage of funds in Centrally sponsored schemes. There are both design and implemen-tation problems. Veteran administrator and rural expert N.C. Saxena points out that under the MGNREGA, funds to States are not allocated on the basis of ‘number of poor’; as a result in poorest States like Bihar and UP, each rural poor received a paltry Rs 918 and Rs 943 against        Rs 12,312 in Kerala, the richest State in the country. The combined share of Bihar, Jharkhand, Odisha, MP and UP, where most of the poor live, was only 25 per cent of total MGNREGA expenditure (2017-18). Similar deficiencies are being noticed in PM Fasal Bima Yojna whose present modified form was introduced in 2016. A farmer is to pay only a premium of 2.5 per cent for kharif and 1.5 per cent for rabi, and 5 per cent for horticulture crops and the balance actuarial premium is to be shared equally by the Centre and State, and the farmer will be fully compensated for farm loss on account of natural calamities. Practical operation of the scheme shows that farmers are not getting full benefit of the scheme—there is delay in assessing loss/damage to the crop, payments are delayed even when the claim has been approved and in many cases genuine claims are denied. The real beneficiaries are general insurance companies, mostly private, who are the main insurers. During 2018-19, 5.2 cr farmers were given insurance under the scheme. While a premium of Rs 25,500 cr was collected, only Rs 20, 200 cr was approved for disbursement, and the insurance companies made a cool profit of over Rs 5,000 cr.

The governments particularly in States are spending huge money on farm loan waiver, mostly to gain electoral mileage. From 2014 to 2018 seven States have granted farm loan waiver, of over Rs 1,70,000 cr- AP (Rs 24,000 cr), Telangana (Rs 17,000 cr), Tamilnadu (Rs 5,300 cr), Maharashtra (Rs 34,000 cr), UP (Rs 36,400 cr), Panjab (Rs 10,000 cr) and Karnataka (Rs 44,000 cr). In 2019 additional farm loan waiver of Rs 60,000 cr was granted by three States—Rajasthan (Rs 18,000 cr ), MP (Rs 36,500 cr) and Chhattisgarh (Rs 6,000 cr), implementing their electoral promise. Such waivers create very adverse impact on the credit culture and seriously jeopardise future recovery of loan and throw the finances of the State into a tailspin. Some States, like Telangana, have introduced generous income support scheme for farmers (annual outgo Rs 12,000 cr). This has been emulated by other States such as AP, Haryana, Jharkhand, Odisha and West Bengal, which have introduced some form of income support schemes from 2018-19. How are they going to finance them is a big question.

The latest subsidy scheme, announced by the Central Government before the elections of May 2019, is an income support programme for marginal farmers. Every cultivator, who has a land holding of less than 2 hectares will get an annual subsidy of Rs 6000. For this scheme known as PM Kisan Samman Nidhi, a sum of Rs 20,000 cr has been allocated in RE 2018-19 and Rs 75,000 cr in BE 2019-20. Finding money for this scheme, when resources are fully stretched, is going to be a herculean task.

Farm Distress- Political Meddling 

While there is real distress in farm and rural sector, the government’s response has been in terms of subsidies and farm loan waiver, but this hardly offers a solution. The biggest cause of rural distress is low prices of agricultural products. When there is a bumper crop prices slump, when there is fall in production due to vagaries from which agriculture suffers, the farmer is not able to take advantage of the market forces as the government intervenes to check prices-often resorts to imports or bans export, in the interest of the consumer and other interest groups. The import of very large quantity of pulses—arhar dal-tur—during 2016-17, when there was bumper production, illustrates the point. The domestic production of pulses had increased by 30 per cent and tur by 50 per cent over the previous two years. The glut in the market forced farmers to sell pulses below the MSP (minimum support price) which itself was fixed very low, below the cost of production. The crash in the prices of pulses and several other agricultural produces during the summer of 2017 led to widespread farmers agitation in the country, which turned violent in Madhya Pradesh, resulting in police firing and the unfortunate death of some farmers. In September/October 2019 the domestic price of onion suddenly shot up. In order to check prices, the government first imposed minimum export price and later when prices went further up, banned export altogether and fixed the stocking limits on traders. India earns substantive money from export of onions—it exported 2.2 million tonnes of onion out of production of 13 ml tonnes in 2018-19 and earned $ 500 ml in foreign exchange. India’s decision of export ban led to onion prices sky-rocketing in Bangladesh, which is India’s top export destination and invited adverse comment from Prime Minster Sheikh Hasina. The decision was taken to pamper the urban consumer and also with an eye on the State elections in Maharashtra, badly hurt onion farmers who lost a lucrative export market. India imports huge quantity of fresh fruits every year, which was of the order of Rs 11,200 cr in 2017-18 and Rs 12,500 cr in 2017-18, and that inevitably pushes down the domestic prices and adversely impacts the farming community. India imports good quantity of apples from the USA, Italy and some other countries, even when it is self-sufficient and the economy of some States such as J&K and Himachal, depend heavily on this fruit. Isn’t it a cruel joke on hapless apple grower?

Our policy-makers keep prices of agricultural products low as they believe in consumerism and promote the interest of a vociferous urban population, without any regard for interest of the helpless farmers. Theodore Schultz, the Nobel Prize winning economist, had observed, ‘The political influence of urban consumers and industry enables them to extract cheap food at the expense of vast number of poor people’, and deliberately under-price agricultural products and have ‘by political means created an indentured agri-culture to supply cheap food for urban people’.

The government’s policies are largely responsible for the impoverishment of agriculture, but politicians in power give them sops to buy their vote, which makes deep hole in public exchequer. No serious effort is made to solve long-term problems which could make agriculture a remunerative occupation. 

There are real structural problems due to which farming in India suffers. More than 80 per cent farms are less than 2 hectare in size and commercially unviable. This calls for land reforms and land pooling system to make them viable. In addition there is growing cost of cultivation due to heavy dependence on high-cost inputs, volatility of crop output and shortage of water. The most critical problem which the agriculture sector faces is lack of investment in agricultural infrastructure calls for massive investment in irrigation, farm machinery and equipment, seeds, post- harvesting handling, storage and processing, and agricultural research and development.

Politicians’ Extravagance

MPLAD: Our politicians/ legislators do not feel that they should set an example of fiscal rectitude. The most glaring case of misuse of public resources is the Member of Parliament’s Local Area Development Scheme (MPLADS), introduced by the Narasimha Rao Government in December 1993. Under the scheme each MP was allocated Rs 2 crores per year, which has been raised to Rs 5 crores from 2012-13, and he/she can select works to be implemented in his/her constituency (in case of Rajya Sabha members, anywhere in the State). Presently the scheme imposes a burden of Rs 3950 cr annually on the exchequer. Between 1993 to March 2019, a whopping sum of Rs 50,600 cr has been spent on the scheme. Veteran parliamentarian and former Chairman of Public Accounts Committee Era Sezhiyan, in a detailed report (2005), had commented that the scheme is a blot on democratic governance and observed that legislators, instead of enforcing accountability of the executive, have themselves assumed the role of the executive. The scheme obstructs the process of decentralisation of authority and resources towards the emergence of village level self-government. The National Commission to Review the Working of the Constitution (2002), headed by Justice Venkatachaliaha had also severely faulted the scheme and recommen-ded its discontinuance. The CAG has conducted several reviews of the scheme and pointed out huge lapses and misuse of fund. Taking a cue from the Centre, almost every State has established an MLA’s fund, with a huge outgo from the exchequer. The scheme is ab-initio unsound and unworkable and should be abolished. 

Pre-election Sops: Today almost every political party offers numerous freebies to lure voters, more particularly before the State elections. When elected to power, the party forming the government implements them to keep the voters’ trust, without bothering about its budgetary implications. The art of giving sops was pioneered by Jayalalithaa when she was the Chief Minister of Tamilnadu. Apart from free/ subsidised rice, and free/subsidised food, the Tamilnadu Government gives free consumer goodies like cycle, laptops, mixer-grinder, fans, livestock, gold for brides and numerous other goodies to certain special section of the population. This brand of politics has a contagion effect and in almost every State, political parties come out with ‘innovative’ schemes before the election to lure the voter. In the NCR of Delhi, the Chief Minister Arvind Kejriwal, desperate to win a second term, has not only given free/ subsidised power and water to a vast section of the population but offered free travel to women in buses and metros—a move that will wreck the finances of the UT of Delhi. Shouldn’t there be a legislation to check such financial profligacy?

The Irony of Indian Democracy

The kind of democracy practised in India imposes a huge burden on the public exchequer and the welfare of an ordinary citizen takes a back seat. There is round-the-year election in the country—Centre, States, Municipal/Panchayat—all of which costs money. A huge security apparatus has been created to protect our legislators, many of whom face criminal charges, which is a big burden on the public purse. Our legislators enjoy liberal salaries and allowances. In addition they have sanctioned for themselves special privileges, such as, lifelong pension for serving only one term, unlimited travel at State cost, State bearing travel cost of an accompany-ing attendant and numerous other perks.

The biggest irony of Indian democracy is that the Executive/Cabinet/ Prime Minister/Chief Minister has become ‘master and dictator of Legislature/ Parliament’ and there is hardly any check on arbitrary exercise of power by the Executive, a sine qua non of democratic functioning. Whatever financial proposal the Executive puts through, while presenting the Annual Budget in Parliament or subsequently in Supplementary Grants gets the legislature’s approval; this has been reduced simply to a formality. The party in power often secures sanction of schemes, which helps it electorally or its special constituency, though they are of dubious value but packaged as beneficent to the masses. Indian democracy hasn’t empowered the people and the medieval power-game of the rich and powerful exploiting the poor and weak continues. Eminent scholar R.H. Tawney (Religion and Rise of Capitalism) had observed, “Few who consider dispassionately the facts of social history will be deposed to deny that the exploitation of the weak by the powerful , organised for the purpose of economic gain, buttressed by an imposing system of law and screened by decorous draperies of virtuous sentiment and resounding rhetoric has been a permanent feature in the life of most communi-ties that the world has yet seen.”

The Way Forward

The makers of the Indian Constitution were visionaries and conscious of the tendency of government of the day to indulge in populism and fiscal profligacy and envisaged a check on them by specifically making a provision under Article 292 (Article 293 for the States), which required Parliament to enact a law to regulate the borrowing by the government. During the Constitutional Assembly debates, Dr B.R. Ambedkar, the main architect of the Indian Constitution, had observed that he can’t imagine Parliament not doing it and even envisaged an Annual Debt Act prescribing or limiting how much it can borrow in that year. However, for over five decades no action to regulate borrowing was taken. It was only in 2004 that the government enacted a Fiscal Responsibility and Budget Management Act (FRBM Act) to bring some kind of fiscal rectitude in the government’s handling of national finances. The FRMB Act, however, has proved toothless, as the targets of revenue deficit, fiscal deficit and overall debt are always breached. These targets are specified in the ‘Rules’, which gives the Executive unfettered discretion to deviate from them and have become simply an instrument of pious intention. For sound management of national finances following the measures are suggested:

1. A legislation needs to be enacted by Parliament which may place a ceiling on government borrowing under Article 292 of the Constitution. This may be a sun-set legislation with a lifespan of five years, co-terminus with the life of the current Parliament. When a new Parliament is elected it may enact a fresh legislation for five years specifying fresh ceiling. 

2. The government’s expenditure may be corelated to revenue (with which debt is discharged) and a legal provision be made that in a particular year the expenditure (both revenue and capital) will not exceed a certain defined percentage of tax-revenue, say, 10 per cent (both for Centre and States).  

3. There should be a legal provision that no borrowing can be made for consumption expenditure and all borrowings will be used only for capital works and projects. 

The above implies that there will be no revenue deficit. Ideally the government should generate revenue surplus to meet its capital expenditure needs.

Germany has passed a constitutional amendment called Schuldenbremse, or debt-break, that outlaws deficit in the national Budget beginning 2016. New Zealand’s FRMB Act states: ‘Once prudent level of total Crown debt has been achieved, maintain this level by ensuring that, on an average, over a reasonable period of time, the total operating expenses of the Crown do not exceed its total operating revenues’ (prudent debt level is interpreted to mean net public debt in the region of 20 to 30 per cent of the GDP)’.

4. Hard and tough measures may be taken to generate more tax revenues. Income-tax rates should be hiked for the super-rich and those earning high income without ‘sweat of their labour’. Loopholes in taxation law should be plugged and unjustified exemptions and concessions be withdrawn. Tax evasion may be severelly punished. Tax policy should aim at the Central Government’s tax-revenue realisation of 15 per cent of the GDP, with the long-term objective of achieving a target of 20 per cent. The overall tax-revenue of the government (Centre and State) should target 25 per cent of the GDP, with the longer term objective of 30 per cent.

Restoring Fiscal Balance

There are some eternal truths, told to us from times immemorial and remain always valid, despite the change in the economic and political environment. One of these truths is ‘live within your means’, “utne hi par phelao jitni chadar ho” (stretch your leg according to cover-let). This wisdom applies not only to personal finance and corporate finance but also to public finance. For several decades the government, in India, has been behaving as if it is in possession of kuber ka Khazana—unlimited wealth and has been on a spending spree and in the process accumulating mountains of debt without realising its adverse consequences. India should not lull itself into the belief that as a sovereign State it can keep on accumulating excessive debt with impunity. In a globalised world, a state can lose the confidence of the market and the inter-national community, which may result in financial cut-off and derail the entire economy. History tells us that those states which had accumulated unsustainable debt faced severe financial crisis leading to civilisational collapse— Spain in sixteenth century, France in eighteenth century and Ottoman Turkey in nineteenth century. Huge public debt was one of the factors that triggered the French Revolution of 1789, as a substantial portion of state revenue was swallowed by debt servicing and the bourgeoisie were unwilling to pay tax to stabilise the budget deficit. Contemporary historian Niall Ferguson (Civilisation—The West and the Rest) observes, ‘It is important to remember that most cases of civilisational collapse are associated with fiscal crisis as well as wars. ...[they] are preceded by sharp imbalances between revenues and expenditures, as well as difficulties with financing of public debt.’ It is time the government takes drastic action to cut wasteful expenditure, mercilessly prune schemes which have no utility and imposes severe austerity measures on public services. Simultaneously it should take tough and coercive action to impose and collect more taxes and generate revenue surplus. The government’s foremost agenda should be freedom from crippling debt and restoring fiscal balance. It is time policy- makers follow Kautilya’s sagacious advice: koshpurvah swarambha—all State activities depends first and foremost on the resources of the Treasury.

B.P. Mathur is a former civil servant and has served as the Deputy Comptroller & Auditor General, Additional Secretary and Financial Adviser, Government of India’s Ministry of Steel & Mines, and Director, National Institute of Financial Management. He holds Ph.D and D.Litt in Economics from the University of Allahabad and has authored several books on governance, finance and economy-related issues.

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