India’s interim budget presented on February 1 claimed that the fiscal deficit – the difference between the government’s total expenditure and its total revenue – would be held to 3.4% of its gross domestic product. This is extremely unlikely to be the case. As the Budget also reported, collections on the Goods and Services Tax front will fall short of the initial February 2018 estimates by at least Rs 1,00,000 crore. Corporate tax collections are supposed to rise by about Rs 50,000 crore over initial budget estimates.
Disinvestment is also likely to fall somewhat short of the target of Rs 80,000 crore despite the government’s sale of its shares in REC (formerly Rural Electrification Corp) to the government-owned Power Finance Corporation, which will take a loan to pay for this deal.
The government had mobilised Rs 34,000 crore until the end of December from its disinvestment process. Once the Power Finance Corporation-REC deal comes through, disinvestment proceeds would rise to Rs 50,000 crore. The government has also sold some of its stake in 19 public sector units and three private sector companies via the Bharat 22 Exchange Traded Fund to raise another Rs 10,000 crore. But the Centre will still be short of its disinvestment target by Rs 20,000 crore.
Tapping sources of revenue
The Government of India is likely to use every option it can think of to try and keep the actual deficit numbers from showing up on the national balance sheet. It is tapping every other source of revenue it can.
For instance, the Reserve Bank of India transferred Rs 28,000 crore as dividend to the government last week. This is an interim dividend payout and the central bank is likely to transfer around Rs 69,000 crore in 2018-’19. (The central bank’s financial year ends on June 30). Another autonomous body, the Securities and Exchange Board of India, is likely to transfer a large portion of its surpluses to the Union government kitty as well.
Another method used to reduce the official deficit is to simply postpone payouts to various government organisations. Since the money has not been spent, it does not show up since the budgeting is reported on a cash basis (a system of accounting when revenue is reported on the income statement only when cash is received and expenses are recorded only when cash is paid out) rather than accrual (when revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid.)
This practice of delayed compensation puts a lot of pressure on the organisations concerned. The Food Corporation of India, for instance, is forced to borrow money for operations because it is a primary target for delayed payouts. It buys, stores, and distributes the food grain that the government doles out via the public distribution system. Since the public distribution system is subsidised, the corporation runs at a loss.
The government is committed to paying off those losses as part of its food subsidy bill but it usually settles only about 50% of the annual Budgeted commitment within the same fiscal year. The accumulated dues have built up to massive proportions and the corporation has to borrow large sums to keep things running.
As of now, the corporation has debt of Rs 1,56,000 crore outstanding. That is, however, not part of the official fiscal deficit. This is money borrowed by a government agency because the government does not have the money to fund operations. Ergo, it is money borrowed by the government. But it will not show up.
Put it all together and the fiscal deficit is very likely to be well above 4% in reality, and possibly closer to 4.5% than to 3.4%. A high fiscal deficit restrict the ability of governments to spend more in areas such as healthcare, education, defence, infrastructure creation, where it is needed.
A fiscal deficit forces the government to borrow, which means that there is less credit available for other borrowers. The government’s demand for credit also leads to interest rates staying high, making credit expensive for everybody. A high fiscal deficit can conceivably lead to a debt trap if the government finds it hard to service outstanding loans. It usually means pressure on the currency and reluctance to invest on the part of overseas entrepreneurs and investors.
Can India print more currency?
Various governments have at various times tried various means of reducing the impact of a high fiscal deficit. One method is to simply default on government debt. In modern times, sovereign default (of government debt) has happened most often in Latin American and Caribbean nations, and quite a few times in Africa as well. It also occurred in Russia in 1998, and in Greece and in the Ukraine. India has never defaulted on debt and government finances are nowhere near bad enough to make that likely.
Another method that is sometimes tried is to simply print notes and attempt to pay off obligations. Union minister Piyush Goyal quite wrongly said that the US government has printed currency to pay off debts. The US has not. But other nations have. The results have usually been disastrous. As the central bank prints more notes, it fuels inflation. This can easily turn into hyperinflation.
Here is a simple way to explain this. Let us say the Reserve Bank of India prints a Rs 2,000 note. The note is worth whatever it can buy. But the bank’s costs are a tiny percentage of that value. So there is a profit called “seigniorage”. The central bank’s accumulated profits (the surplus it transfers to the government) broadly arise from that. So by printing an appropriate quantum of currency, which the RBI lends to the government, it can cover the fiscal deficit. What is more, it can transfer its profits to government.
Doesn’t that seem clever?
This, however, does not work because as currency floods the system, inflation rises and that money can buy less in the way of goods and services. In hyperinflation scenarios, such as in Argentina and Zimbabwe, the notes become worthless. The seigniorage profit erodes and finally disappears when trillion-dollar notes are being printed, as in Zimbabwe, and a loaf of bread costs more than a trillion. Argentina used to ritually lop zeros off the currency, as annual inflation ran at five figures. This sort of implosion can happen very quickly if people lose faith in the currency.
India is not anywhere near that state of desperation yet, and it has lived with higher fiscal deficits than 4.5%. However, since growth is probably being overstated and over-estimated at the moment, the fiscal deficit is of genuinely worrying proportions. It is also frightening that supposedly responsible senior ministers are suggesting lunacies like printing money to plug the gap as Goyal did earlier this month. After demonetisation, maybe this will be the next great attempt at financial reform in India.