The Hindu Business Line : Other side to ‘borrow-and-spend’

The ultimate test of Mr Pranab Mukherjee’s Budget is not going to be whether it will end up further bloating the Centre’s balance-sheet, but whether it would help revive a sagging economy.

Harish Damodaran

Mr Pranab Mukherjee’s Union Budget 2009-10 has been lampooned by many as a ‘borrow-and-spend’ exercise.

This is worse than a ‘tax-and-spend’ Budget, in which there is some basic correspondence between what the Government earns and the expenses it incurs. In the ‘borrow-and-spend’ model, a significant chunk of its spending is fina nced not through income from tax and non-tax sources, but by monies raised from the market.

Thus, while in 2007-08, revenue receipts (net of States’ share of taxes) funded over 76 per cent of the Centre’s total expenditures, the proportion is expected to dip to 60.2 per cent this fiscal. Gross market borrowings during 2009-10, at Rs 4,51,093 crore, will be 47 per cent higher than the Rs 3,06,000 crore for the previous fiscal and 2.7 times the Rs 1,68,101 crore level of 2007-08.

Obvious risks

‘Borrow-and-spend’ policies, whether by governments or even firms and households, have obvious risks attached to them. Borrowings, after all, entail interest charges. If the mismatch between spending and earnings grows over time to necessitate ever larger borrowings, a time will come when interest itself becomes a sizable expense — not just pre-empting an increasing share of whatever little revenues, but also crowding out other (more useful) expenditures.

The question to ask is: Has this point already been reached? The answer: Well, probably not yet. The accompanying table shows that the Centre’s interest outgo as a percentage of GDP rose through the 1990s before touching 4.8 in 2002-03.

Since then, it has actually declined to a low of 3.55 per cent in 2008-09. While the interest-GDP ratio is budgeted to increase to 3.85 per cent this fiscal, it is still nearly 100 basis points below the 2002-03 peak.

More interesting is the evidence with regard to crowding out and pre-emption. In 1990-91, interest costs constituted a fifth of the Centre’s total expenditures. By 2000-01, the share had crossed 30 per cent, only to again steadily fall to the original one-fifth — a level that has not changed much even in the Budget estimates for this fiscal.

A similar trend holds when one looks at how much of the Centre’s revenue receipts (tax plus non-tax) are consumed by interest payments. This proportion increased from 39 per cent to more than 53 per cent between 1990-91 and 2001-02. But over the next 5-6 years, it had dropped to less than a third. While the ratio has gone up recently — courtesy the huge slowdown-induced dent in tax collections — it is still well below earlier levels. Simply put, the Centre’s interest burden (a consequence of its borrowings) is today not a drag on its finances or the broad economy (if percentages to GDP are an indicator) the way it was till only a few years ago.

Some of this is, no doubt, an outcome of the low interest rate regime that prevailed during the early part of this decade. Between 2000-01 and 2006-07, the average interest rate on the Centre’s outstanding market loans came down from 13 per cent to 8.9 per cent.

This was accompanied by some deft financial manoeuvring from the Finance Ministry’s side — for example, swapping nearly Rs 1,00,000 crore worth of 10.5 per cent interest-bearing ‘special securities’ issued in the past to the National Small Savings Fund with fresh paper of 6-7 per cent coupon. All this gave the leeway to borrow more without entailing any extra interest outgo.

But soft interest rates only tell part of the story. Note that even in 2003-04 — when the weighted average yield on its primary bond issuances hit an all-time-low of 5.71 per cent — the Centre’s interest percentages to GDP, expenditures and revenue receipts remained unacceptably high.

Strong GDP growth

The real declines in these ratios happened with the unprecedented GDP growth rates that followed. As the Indian economy expanded at a sustained 8-9 per cent rate over five years, so did tax revenues and, with it, also the Centre’s wherewithal to further augment spending. As a result, its interest burden shrank in relative terms.

It stands to reason, then, that the crisis today is truly not one of increased government borrowing, but of a growth slowdown. Borrowings by themselves are not a problem so long as there is the underlying GDP growth and revenue buoyancy to service them.

The ultimate test of Mr Mukherjee’s Budget is not going to be whether it will end up further bloating the Centre’s balance-sheet, but whether it would help revive a sagging economy.

This is something that ‘bond vigilantes’, too, need to consider before deciding to dump government stock and driving up yields.

The alternative, of course, is not to borrow and leave recovery entirely to chance, even if it entails a further hit to revenue collections.

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