Fiscal math may not dictate Budget spend

Govt keen to show positive demonetisation effects though social spending

The government plans to show a massive increase in public investment expenditure in Budget 2017-18 even if that means making some compromises with the fiscal deficit figures.

Senior finance ministry officials are working out several options to make this possible as the government plans to show that demonetisation has offered substantial gains to the people. Most of the increase will be in social sectors such as health, education, drinking water and sanitation.

“There is a lot of scope to expand expenditure and we are working out the alternatives”, said a top government official. The need to redo the math has become necessary following directions from the political leadership.

Last week Bharatiya Janata Party President Amit Shah told its Members of Parliament that it will not make sense for the government to present an incremental Budget with Plan expenditure almost unchanged over the past few years. “Our efforts against black money must create space for our Plan Budget to reach Rs 15 lakh crore in two years”, a source present at the meeting quoted him as saying.

The fiscal math could be as follows. 

First, banks are short of government papers to invest in because of the huge surge in deposits. The yields on the benchmark government papers have come down since November 8 when demonetisation was announced, as banks have rushed to buy more of them (price and yields of debt papers move in opposite direction). For the financial year 2017-18 then, the government has the opportunity to borrow substantially more from the market than it has done in 2016-17, without crowding out private investment. The Reserve Bank of India (RBI), for instance, has had to announce special bonds under the market stabilisation scheme in November as deposits surged. That money lies sequestered with RBI.

For next financial year, the finance ministry will massively expand the borrowing window and use the money to finance the higher spending for schemes. While this will create pressure on the fiscal deficit numbers, the government’s managers are willing to make the trade-off. This is also possible as interest rates are now soft and so the repayment load on the government is expected to be manageable.

In a note on the impact of demonetisation, S&P Global Ratings credit analyst Geeta Chugh, noted last week, “The banking sector will face marginally negative pressure in the short run as loan growth will remain soft, and asset quality and earnings will be pressurised at the margin”. Those earnings numbers could improve with a larger basket of government borrowings. 

The second option is through reclassification of numbers. In Budget 2017-18, the finance ministry has decided to jettison the difference between Plan and non-Plan expenditure. Officers in the ministry are working to integrate the capital expenditure component of the latter to showcase a substantial jump in investment expenditure.

Third, the government plans to integrate some of the internal and extra-budgetary resources (IEBR) of state-run companies within the overall investment figures. Up till this financial year, in the annual expenditure budgets, the finance ministry has mentioned the IEBR as an addition to the plan expenditure committed by the government. But the sum is netted out from calculations of total expenditure. In the IEBR table, presented as part of the expenditure budget, the companies would show their anticipated spending on investment divided into their internal resource, as support from the central government and borrowings from domestic and offshore capital markets. Only the support from the government expenditure would form part of the expenditure budget. 

Public finance expert D K Srivastava, a member of 12th Finance Commission, however, says integrating IEBR within government capex could be difficult. “With the eclipse of the Plan Budget, the basis of the IEBR table and its linkage with the central budget has come into question”. One of the alternatives, he said, would be to show bridge items such as special-purpose vehicles for investment in specific sectors with funding from the central government and by state-run companies. In any case, the result of this exercise is expected to make government capital expenditure soar next financial year. Since this is the first year of the new nomenclature with a deep and persisting slowdown in private investment, the official said it would be “ridiculous” if the erstwhile Plan expenditure and the new head of capital expenditure show broadly the same numbers. 

The need to substantially bolster government investment has also become necessary as all other sectors are blinking red. “Investment, particularly private investment, which is already down and out due to various reasons, will face the brunt of the demonetisation. IndRa now expects gross fixed capital formation for FY17 to grow at two per cent, down 306 basis points from our earlier projection,” says a note by Sunil Kumar Sinha, principal economist, IndRa, on December 1. While IndRa expects the fiscal deficit to remain untouched, the government is expected to do so.

The reasons are clear. In a bleak economic context, while some of the options such as reclassification of government expenditure were in the works for some time it has become necessary to recast the Budget numbers in a different mould altogether, to convince the public about the results of the demonetisation exercise. The large scale up-shift in total government expenditure is expected to be one of them.