Fiscal engineering is name of the game: Business Line 10th March 2018

Government has been smartly re-routing its borrowings from Budget to public sector entities. Is this sustainable economics?

The fiscal deficit number is probably one of the most intriguing variables in economics. This is so because there is an overemphasis on this number; it draws more attention than necessary, and the quality of the deficit is missed. The deficit ratio has become sacrosanct over the years with all the rating agencies and multilateral institutions focusing on this number. It is but natural that the Government too becomes defensive on this number, which becomes the ultimate parameter for judging the Budget.

The fiscal deficit is sum of all borrowings of the Centre, which includes market borrowings as well as other flows such as small savings, State provident funds, other deposits and drawdown of cash balances. The last component helps in keeping the fiscal deficit within the range that is targeted. Hence, if there is a breach in the target by, say, 0.1-0.2 per cent, such drawdowns are resorted to.

The other expenditure

As budgets are all about tracking actual revenue and expenditure, the first line of defence in maintaining the deficit ratio is to simply defer expenditure so that it gets rolled over. This way the deficit ratio can be geared towards what is desired through the rollover technique. This is a common method followed to ensure that the final number is digestible. Of late, another approach that has been used to balance the budget while targeting higher expenditures is to is to re-engineer the borrowing numbers to outside the Budget.

The task of borrowing is passed on to PSEs instead and included in the Budget discourse. The PSEs are strictly speaking corporate entities and run their own balance sheets and, hence, are responsible for their accounts. The Government steps in only in case there is a major problem as is being witnessed in Air India. But these entities operate in all major sectors that require heavy investment, such as roads, railways, power, oil and engineering. Here, there is a large demand for funds as investment requirements are high.

 

Public sector assistance

A way out of this conundrum is to shift the borrowing to the PSEs from the Budget. This way the fiscal deficit is well under control while the development programmes are still on as they are financed commercially by the PSE. The cost of borrowing will be higher here, albeit marginally, as they are considered to be as good as the Central government and have such implicit backing.

Therefore, in terms of an accounting entry, these borrowings become part of the contingent liability of the Government if they are guaranteed or remain completely out of the realm if done without such a backing. The PSEs borrow this amount on commercial terms and as they are the more successful ones do not face a problem in servicing these loans as they are rated the best in the market. Therefore, when the Budget speech is read carefully it will be seen that often the FM makes fairly elaborate announcements regarding investment in roads or railways and the numbers do not fit in the Budget allocation. This is so because the requisite entity like say Indian Railway Finance Corporation (IRFC) for railways or National Highways Authority of India (NHAI) for roads do the job where money is borrowed and used for financing investment in these sectors.

Since 2015-16, there has been a greater reliance on this form of funding which has doubled from around ₹60-70,000 crore in 2014-15 and reached almost three times that by 2017-18. This is when the Government has also been aggressive in its capex in the relevant sectors which have been identified with high growth potential.

Such engineering has ensured that the fiscal deficit seems to be asymptotically reaching the 3-per cent mark, though still missing the target. The comparable number including these PSE borrowings would be at almost the same level as in 2014-15 at 4.6 per cent. The difference between the two deficit numbers is now around 1 per cent of GDP — which was around 0.5 per cent earlier.

Is there anything incorrect about such a route being used? The answer is no, as this is plain financial engineering where borrowings are deflected from the Budget to the commercial entity which works like any private company. Should this be a part of the borrowing programme? Here there are divided views.

Number games

International rating agencies normally tend to look at public sector borrowing as being a part of the Government debt and, hence, would include in the deficit because at the end of the day the amount has to be paid. However, they miss the detail on the asset side as the Government and the PSEs own large assets whose monetary value far exceeds the size of the debt.

Second, at times it is argued that if the government can take in the profits of the PSEs as part of its non-tax revenues, then the debt should also reside with the Centre. It cannot eat the cake and have it too.

The counter arguments are that commercial entities which are answerable to their shareholders cannot be treated as the Government even in case majority ownership resides with it.

The Government’s support for such enterprises comes from the Budget through allocations towards say capital for banks or even PSEs which is already accounted for and hence the same cannot be double-counted.

However, those advocating the inclusion say if this were so then the Budget should not be talking about it as part of its plan, for these should then be taken to be external to the Government and part of their commercial decisions. This point is valid as if these plans are not part of the Budget then the same should not be mentioned in the document. The debate will go on.