What the fiscal deficit doesn’t tell you

There has been so much noise around the haloed 3.3 per cent fiscal deficit figure, that the crux of the Centre’s debt/borrowing issue has long been underplayed. Bond markets have been on a high ever since the Finance Minister, Nirmala Sitharaman, retained the fiscal deficit ratio for the current fiscal laid down in the interim Budget.

But then the fiscal deficit ratio, in itself, is beginning to hold little relevance given the umpteen assumptions built into it. With dodgy estimates on expenditure and revenue in the numerator and stretched assumptions on GDP growth in the denominator, achieving the ‘picture perfect’ fisc ratio is not a difficult task.

But there is more than meets the eye.

Rising borrowings

The provisional actual figures for 2018-19 that were released by the Controller General of Accounts (CGA), way before the Budget, had revealed a massive shortfall in tax revenues to the tune of ₹1.67-lakh crore. To achieve its intended 3.4 per cent fiscal deficit number for 2018-19 fiscal, the Centre had slashed its expenditure. Aside from some unsettling aspects (discussed later) of this balancing act, there is now a wider concern.

In the latest Budget, the projections of the current fiscal (2019-20) have been made against revised estimates of last fiscal rather than CGA’s actual provisional figures. Interestingly, the Centre still managed to retain its 2019-20 revenue and expenditure projections, by bumping up its estimates on disinvestment, spectrum receipts and dividend from the RBI. By assuming a stretched nominal GDP growth of 12 per cent, the Centre has effortlessly managed to please the market with a 3.3 per cent fiscal deficit figure.

But the problem with such a narrow view of the fiscal deficit is that it completely glosses over the critical issue of rising government borrowings.

The alarmingly high gross borrowings of the Centre, pegged at ₹7.1-lakh crore for the current fiscal, is a steep 24 per cent increase from the ₹5.7-lakh crore last fiscal. Such large borrowings lead to crowding out of the private sector and add pressure on domestic interest rates and liquidity. Hardening of G-Sec yields has a cascading effect on other financial market instruments, feeding into inflation through input costs and creating a vicious cycle.

Add to the Centre’s borrowings, is the concern of a steep rise in State borrowings in recent years. From ₹1.96-lakh crore in 2013-14, gross State borrowings shot up to ₹4.78-lakh crore in last fiscal (2018-19). State Development Loans (SDLs) crowd out corporate borrowings in the bond market by increasing costs.

High rated corporate bonds have a greater propensity for being crowded out by SDLs which work as substitutes, according to an RBI study. The gross borrowings of the Centre and the States together are now about 5.5 per cent of GDP (in 2018-19).

More borrowings

Then there are other borrowings that often go unnoticed. Let’s consider the slashing of expenditure last fiscal (we talked about earlier) to meet the 3.4 per cent fisc ratio. A major portion of the reduction in expenditure (revenue) came from crimping on food subsidies by about ₹69,000 crore. But this is nothing more than an accounting jugglery.

According to data available on Food Corporation of India (FCI) website, the per cent of subsidy released to it by the Centre has been falling significantly over the last five-odd years. The FCI, which was borrowing from banks at a higher cost to meet its short-term requirements, started borrowing from the National Small Savings Fund (NSSF) in 2016-17 — the Centre approving such loans to meet the food subsidy requirements.

From ₹70,000 crore in 2016-17, the FCI’s loan from NSSF has gone up to ₹1.91-lakh crore in 2018-19. With these loans outside the Budget — constituting borrowings of public sector agencies — the fiscal deficit ratio appears to be under control. But aside from understating the fisc, such large borrowings risk the government getting itself into a debt trap. Remember, repayment of such loans is ultimately the Centre’s obligation and hence it only increases its future liabilities and interest commitment. The government has also been dipping into the pool of small savings to finance its fiscal deficit and fund the needs of public institutions.

From ₹12,357 crore in FY14, financing through small savings jumped to a little over ₹1-lakh crore in FY18. In FY19, as against the budgeted ₹75,000 crore, the Centre borrowed ₹1,25,000 crore (as per interim Budget). For FY20, financing through small savings is pegged at ₹1.3-lakh crore.

Remember small savings rate are kept high to ensure adequate flows into small savings. Hence financing through NSSF comes at a high cost. The government has also dipped into this pool to fund public agencies like FCI, NHAI, etc. The FY18 Budget reveals that NSSF’s investment in public agencies has been ₹1.06-lakh crore — ₹65,000 crore in FCI and ₹20,000 crore in NHAI.

In FY19, additional investments in public agencies — NHAI, PFC, REC, IRFC and others — is over ₹1.5 lakh crore. Since NSSF also parks funds in G-Secs, any direct drawdown from the fund reduces NSSF’s purchases of government bonds in the market — in turn exerting pressure on G-Sec yields.

Then there is the growing reliance of the Centre on off-balance sheet borrowing — funds raised by central public sector enterprises — and Internal and Extra Budgetary Resources (IEBR) in recent years to fund capital expenditure. If the borrowings of the Centre, States and public sector agencies are put together, they exceed 7 per cent of GDP.

What’s more, the humongous ₹1.9-lakh crore of capital infused into PSBs in the last two fiscals has been done through the issue of recap bonds that don’t count under fiscal deficit calculation (another ₹70,000 crore budgeted for the current fiscal). Sooner or later the interest and face value on these bonds will have to be repaid by the Centre.

By paying too much attention to just the fiscal deficit ratio, aren’t we missing the wood for the trees?

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