Centre was sensitive to fiscal deficit: Garg on CAG's bank recap concerns

Subhash Garg, the Department of Economic Affairs (DEA) secretary during the years when the Comptroller and Auditor General (CAG) of India had flagged the issue of the finance ministry not showing bank recapitalisation as fiscally non-neutral, said the government at that time was sensitive to fiscal deficit.

The government can now show recapitalisation as affecting deficit. The government is no longer sensitive to fiscal deficit as it was raised to 9.5 per cent of gross domestic product (GDP) in the Revised Estimates (RE), from 3.5 per cent in the Budget Estimates (BE) for the current fiscal year, Garg told Business Standard.

The CAG had raised this issue for the Budgets of 2017-18 (FY18) and 2018-19 (FY19). Garg was DEA secretary from July 5, 2017, to July 26, 2019. He was responsible for the Budget-making exercise for one of these two years — FY19. He was also finance secretary from March 1, 2019, to July 26, 2019.

“I assume the government then was conscious about keeping fiscal deficit low. The government’s sensitivity towards fiscal deficit is no longer there. Fiscal deficit was raised to 9.5 per cent of GDP by paying the Food Corporation of India’s past liabilities. If it were to be done today, we should see how this RS 20,000 crore of last year or the current year has been treated on the fiscal account as asset and liability,” he said.

In its report presented to Parliament last month, the CAG had pulled up the government for not factually showing in the FY18 and FY19 Budgets that bank recapitalisation of public sector banks (PSBs) is fiscally non-neutral.

The CAG said the government made an investment of Rs 80,000 crore in FY18 and Rs 1.06 trillion in FY19 for recapitalisation of PSBs.

Funds for these investments were raised by the government through the issue of non-transferable special securities to the same PSBs.

The CAG noticed that in the Expenditure Budget, the abovementioned expenditure on recapitalisation of PSBs had been netted against receipts from issue of special securities. In the Receipt Budget, receipts from securities had been netted against expenditure on recapitalisation.

This treatment is reflected in the computation of fiscal deficit in Budget At a Glance (BAG) and in the Medium-Term Fiscal Policy Statement (MTFPS). However, in the Union Government Finance Accounts, the securities issued to PSBs have been correctly accounted as internal debt of the government and receipts from the same as debt receipts.

CAG said netting of these receipts against expenditure on recapitalisation and investment in PSBs in BAG and MTFPS was not in line with the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.

The finance ministry agreed that that bank recapitalisation, although cash-neutral, is not fiscally neutral since the issue of securities would get reflected in total government debt. Besides, coupon payments for special securities when made would be reflected in the fiscal deficit of the relevant year.

Fact remains that the expenditure should have been shown separately from receipts and not netted, said CAG.

If bank recapitalisation is shown in fiscal deficit, the gap between the Union government’s expenditure and revenue would have increased to 3.7 per cent of GDP in FY18, against 3.5 per cent shown in the Budget. Similarly, the Centre’s fiscal deficit would have risen to 3.9 per cent of GDP in FY19, against 3.4 per cent shown in the Budget.

If recapitalisation is now shown in next year’s Budget as expenditure, fiscal deficit would become 9.6 per cent on account of the ~20,000 crore of recapitalisation account, from 9.5 per cent shown in the RE for 2020-21. For 2021-22, the deficit would increase to 6.9 per cent of GDP, from 6.8 per cent from the BE on account of Rs 20,000 crore of recapitalisation.

To a query whether the treatment of recapitalisation on the fiscal account was against the FRBM Act of 2003, the former economic affairs secretary said it was if one were a fiscal purist.

He said investment in banks should be shown as capital expenditure and investment by banks in bonds as borrowings of the government.

“If you treat that, then the bank recapitalisation would be non-neutral on the fiscal account and it would raise fiscal deficit and by the same amount, liabilities would go up automatically. Purist fiscal treatment is this,” he said.

To that  extent, what the CAG said is correct, said Garg.

“However, the CAG also probably noted that the government had intended to make it fiscally neutral. Worse could have been that you don’t show it as an increase in government liability. But that was not done. The government transparently showed that liabilities went up. But to depress fiscal deficit or keep it lower, it was kept as neutral. It should have been disclosed on both sides as investment and borrowing and fiscal deficit should have also gone up,” he said.