rock and a hard place

The real picture of India’s finances is terrifying

July 10, 2014
Obsession
Modinomics
July 10, 2014

For all its promise of hitting the reset button on the Indian economy, the new government has very limited room to manoeuvre. It’s the common budgetary bane, be it for a household, a corporation or a government—living beyond its means.

India has been living beyond its means to such an extent that making available funds for new, transformational ideas—to fire up growth, or to create thousands of new jobs, or to lift millions out of poverty—is likely to be a hugely compromised exercise. And even that will require a deft political touch.

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In financial year 2013-14, which ended this March, the Indian government was expected to earn Rs1,056,000 crore ($176 billion) in revenues. For the sake of simplicity, assume this to be Rs100. Of this, Rs83.7 came from taxes levied on companies and individuals, and the remaining Rs16.3 from dividends received from state-owned firms and the charges levied by government to provide services.

But for this Rs100 that it received, the Indian government ended up spending Rs157.6. During the past decade, while the size of the Indian profit and loss account has increased by 3.5 times, the revenue-expenditure imbalance has kept pace.

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What makes it worse for the government is the inelasticity on both the revenue and expenditure sides, which limits its options.

The government, for the most part, can neither dramatically increase revenues nor erase expenditure. Take the revenue side, which is dominated by taxes. A spike can come from either increasing tax rates or greater buoyancy in collections. The government is unlikely to raise taxes in an economy moving in second or third gear. And buoyancy in collections can come only from a dramatic improvement in the economy.

Now, take the expenditure side, which added up to Rs157.6 for every Rs100 of revenues. The government is living way beyond its means. As much as Rs137.6 of this Rs157.6 is going towards meeting running expenses, as opposed to creating assets that deliver benefits in later years. And just five items—interest payments, defence spending, subsidies, salaries and pensions—account for Rs110.

The biggest outgo on the expenditure side, of Rs51.4, is interest payments to service loans and to buy back past debt. Since most of it is being used to fund running expenses, in inter-generational terms, it is akin to making the future generation pay for current expenses. The government can’t retire this debt because, well, it can’t—it doesn’t have the money to do so and that is what balances the books today. If a credit card user were to be in this situation, his condition would be described as being in a debt trap.

The next biggest item is defence spending, of Rs 30.1. Here, too, the government has its hands tied. It won’t dare slash its defence budget, given India’s history of hostilities with neighbours Pakistan and China, and a military corps that has been crying for equipment upgrades and that has had to endure grave mishaps in recent times. The Narendra Modi government in particular, which maintains a hawkish stance on national security, can’t afford to be seen as slashing defence allocation.

Salaries and pensions for government employees account for another Rs18.5. The government can signal its intention to maintain a leaner bureaucracy today, as has been its stated position. But it will take years to free up money on the books.

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The only expenditure item where it can squeeze out something significant is subsidies, which amounted to Rs21.9 in 2013-14. This is the largesse given out by the government, on the pretext of protecting the poor and the vulnerable, on fuel, fertilizer and food. But large parts of it don’t end up in the hands of the needy.

For example, the original rationale of subsidizing diesel was that farmers use it to pump water for irrigation. But most of the diesel is today consumed by cars and sports utility vehicles, whose owners ought to pay market prices. The government needs big chunks of funding to channel into two areas that touch lives of people and that can have a multiplier effect—spending on social services (like education and health) and economic services (like agriculture, power and transport). And this is where the real picture of our misplaced priorities emerge. In 2013-14, the government spent a mere Rs2.3 on each of those categories.

It can come from reducing expenditure, which is possible only with subsidies. Or, it can come by earning more revenues, where perhaps the only option is to sell stakes to private players in the array of companies owned by the government in just about every sector. Both will require political will. And they, by themselves, might not be enough to achieve a change that is transformational.

This article is a part of Quartz India. For more, follow this link.

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