One of my abiding memories of growing up in a small town is of my father and his friends talking about insurance agents and chit fund agents taking money and disappearing. Usually the agent used to be someone known to them. One story that I remember is of the local dhobi’s (washerman’s) son raising money for a chit fund and then disappearing.
The present day version of this plays out when people invest in wrong kind of insurance policies where the agent commissions are very high or in Ponzi schemes which promise high returns. Ponzi scheme are essentially financial frauds where the money being brought in by the new investors is used to pay off the older investors whose investment needs to be redeemed. They collapse the moment the money leaving the scheme becomes higher than the money entering it.
One version of the Ponzi scheme is a Ponzi scheme masquerading as a multi-level marketing scheme. Those who invest in such schemes end up investing through relatives, friends, neighbours etc. These are essentially people they know and they trust.
One reason why people end up investing money in such avenues is financial illiteracy. While people work hard at earning the money that they do (in most cases), they are very lazy when it comes to investing this hard earned money. They don’t like to carry out any basic research and just hand over their hard earned money to others who they trust.
Hence, trust is another factor at work. In many cases where individuals end up making wrong investments, they invest through an agent who is either a friend or a relative or perhaps someone known to them. This situation is termed as an affinity fraud.
Jason Zweig defines affinity fraud in his book The Devil’s Financial Dictionary as “a financial crime committed by someone with an affinity for doing terrible things to his friends, as when a crook promotes a bogus investment to members of his church, social club, ethnic group, or other close-knot community.” In the Indian context Ponzi schemes masquerading as chit funds or multi-level marketing schemes and being sold to members of a closely knit community are a very good example.
So why do people become victims of the affinity fraud. As Zweig writes about people who victims of the affinity fraud: “They trust him [the agent/the crook] because they know him so well. In return, he trusts them not to notice that he is stealing their money.”
In fact, the human need to trust others and be social is a direct impact of evolution and the fact that human beings are born prematurely in comparison to other animals. As Yuval Noah Harari writes in Sapiens—A Brief History of Mankind: “Humans are born prematurely, when many of their vital systems are still underdeveloped. A colt can trot shortly after birth; a kitten leaves its mother to forage on its own when it’s just a few weeks old. Human babies are helpless, dependent for many years on their elders for sustenance, protection and education.”
And this led to a situation where human beings have had to be social and in the process trust the people around them. As Harari writes: “Raising children required constant help from other family members and neighbours. It takes a tribe to raise a human. Evolution thus favoured those capable of forming strong social ties. In addition, since humans are born underdeveloped, they can be educated and socialised to a far greater extent than any other animal.”
Hence, for human beings to survive and progress in the society, they need to be social and trust the people around them. And this as Harari writes “has contributed greatly both to humankind’s extraordinary social abilities and to its unique social problems”.
One of these social problems is the affinity fraud where we trust others with our money. And sometimes this turns out be a huge blunder. So, the next time you lose money by making a wrong investment through someone know you know, you can blame evolution for it.
(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])
The Reserve Bank of India(RBI) releases the Financial Stability Report twice a year. The second report for this year was released yesterday (i.e. December 23, 2015). Buried in this report is a very interesting box titled In Search of Some Old Wisdom. In this box, the RBI has resurrected the economist Hyman Minsky. Minsky has been rediscovered by the financial world in the years that have followed the financial crisis which started with the investment bank Lehman Brothers going bust in September 2008.
So what does the RBI say in this box? “When current wisdom does not offer solutions to extant problems, old wisdom can sometimes be helpful. For instance, the global financial crisis compelled us to take a look at the Minsky’s financial stability hypothesis which posited the debt accumulation by non-government sector as the key to economic crisis.”
And what is Minsky’s financial stability hypothesis? Actually Minsky put forward the financial instability hypothesis and not the financial stability hypothesis as the RBI points out. I know I am nit-picking here but one expects the country’s central bank to get the name of an economic theory right. I guess given that the name of the report is the Financial Stability Report, someone mixed the words “stability” and “instability”.
The basic premise of this hypothesis is that when times are good, there is a greater appetite for risk and banks are willing to extend riskier loans than usual. Businessmen and entrepreneurs want to expand their businesses, which leads to increased investment and corporate profits.
Initially, banks only lend to businesses that are expected to generate enough cash to repay their loans. But as time progresses, the competition between lenders increases and caution is thrown to winds. Money is doled out left, right, and centre and normally it doesn’t end well.
This is the basic premise of the financial instability hypothesis. In this column I will explain that the Indian corporates have reached what Minsky called the Ponzi stage of finance. Minsky essentially theorised that there are three stages of borrowings. The RBI’s box in the Financial Stability Report explains these three stages. Nevertheless, a better explanation can be found in L Randall Wray’s new book, Why Minsky Matters—An Introduction to the Work of a Maverick Economist.
As Wray writes: “Minsky developed a famous classification for fragility of financing positions. The safest is called “hedge” finance (note that this term is not related to so-called hedge funds). In a hedge position, expected income is sufficient to make all payments as they come due, including both interest and principal.” Hence, in the hedge position the company taking on loans is making enough money to pay interest on the debt as well as repay it.
What is the second stage? As Wray writes: “A “speculative” position is one in which expected income is sufficient to make interest payments, but principal must be rolled over. It is “speculative” in the sense that income must increase, continued access to refinancing must be expected, or an asset must be sold to cover principal payments.”
Hence, in a speculative position, a company is making enough money to keep paying interest on the loan that it has taken on, but it has no money to repay the principal amount of the loan. In order to repay the principal, the income of the company has to go up. Or banks need to agree to refinance the loan i.e. give a fresh loan so that the current loan can be repaid. The third option is for the company to start selling its assets in order to repay the principal amount of the loan.
And what is the third stage? As Wray writes: “Finally, a “Ponzi” position (named after a famous fraudster, Charles Ponzi, who ran a pyramid scheme—much like Bernie Madoff’s more recent fraud”) is one in which even interest payments cannot be met, so that the debtor must borrow to pay interest (the outstanding loan balance grows by the interest due).”
Hence, in the Ponzi position, the company is not making enough money to be able to pay the interest that is due on its loans. In order to pay the interest, it has to take on more loans. This is why Minsky called it a Ponzi position.
Charles Ponzi was a fraudster who ran a financial scheme in Boston, United States, in 1919. He promised to double the investors’ money in 90 days. This was later shortened to 45 days. There was no business model in place to generate returns. All Ponzi did was to take money from new investors and handed it over to old investors whose investments had to be redeemed. His game got over once the money leaving the scheme became higher than the money being invested in it.
Along similar lines once companies are not in a position to pay interest on their loans they need to borrow more. This new money coming in helps them repay the loans as well as pay interest on it. And until they can keep borrowing more they can keep paying interest and repaying their loans. Hence, the entire situation is akin to a Ponzi scheme.
By now, dear reader, you must be wondering, why have I been rambling on about a single box in the RBI’s Financial Stability Report and an economist called Hyman Minsky.
In RBI’s Financial Stability Report the box stands on its own. But is the RBI dropping hints here? Of course, you don’t expect the central bank of a country to directly say that a large section of its corporates have reached the Ponzi stage of finance. And there are many others operating in the speculative stage of finance. Even without the RBI saying it directly, there is enough evidence to establish the same.
In the report RBI points out that as on September 30, 2015, the bad loans (gross non-performing advances) of banks were at 5.1% of total advances of scheduled commercial banks operating in India. The number was at 4.6% as on March 31, 2015. This is a huge jump of 50 basis points in a period of just six months.
The restructured loans of banks fell to 6.2% of total advances from 6.4% in March 2015. A restructured loan is a loan on which the interest rate charged by the bank to the borrower has been lowered. Or the borrower has been given more time to repay the loan i.e. the tenure of the loan has been increased. In both cases the bank has to bear a loss.
The stressed loans of banks, obtained by adding the bad loans and the restructured loans, came in at 11.3% of total advances. They were at 11.1% in March 2015. The numbers for the government owned public sector banks were much worse. The stressed loans of public sector banks stood at 14.1%. In March 2015, this number was at 13.2%. This is a significant jump in a period of just six months. The stressed loans of private sector banks stood at a very low 4.6% of total advances.
Let’s look at the stressed loans of public sector banks over a period of time. In March 2011, the number was at 6.6% of total advances. By March 2012, it had jumped to 8.8% of total advances. Now it is at 14.1%.
What is happening here? Banks are clearly kicking the can down the road by restructuring more loans, because many corporates are clearly not in a position to repay their bank loans. Why do I say that? As the Mid-Year Economic Review published by the Ministry of Finance last week points out: “Corporate balance sheets remain highly stressed. According to analysis done by Credit Suisse, for non – financial corporate sector (based on ~ 11000 companies in the CMIE database as of FY2014 and projections done for FY2015 based on a sample of 3700 companies), the number of companies whose interest cover is less than 1 has not declined significantly (this number was 1003 in September 2014 and is 994 in September 2015 quarter).”
Interest coverage ratio is essentially obtained by dividing the earnings before interest and taxes(operating profit) of a company during a given period, by the interest that it needs to pay on the loans that it has taken on.
In the Indian case, a significant section of the corporates have an interest coverage ratio of less than 1. This means that they are not earning enough to even pay the interest on their outstanding loans.
Further, the weighted average interest coverage ratio of all companies in the sample as on September 2015 was at 2.3. It was at 2.5 in September 2014. As the Mid-Year Economic Review points out: “Research indicates that an interest cover of below 2.5 for larger companies and below 4 for smaller companies is considered below investment grade.”
What this means that many corporates now are not in a position to even pay interest on their loans. They need newer loans to repay interest on their loans. They have reached the Ponzi stage of finance, as Minsky had decreed. Still others are in the speculative stage.
The RBI Financial Stability Report again hints at this without stating it directly. As the report points out: “Bank credit to the industrial sector accounts for a major share of their overall credit portfolio as well as stressed loans. This aspect of asset quality is related to the issue of increasing leverage of Indian corporates. While capital expenditure (capex) in the private sector is a desirable proposition for a fast growing economy like India, it is observed that the capex which had gone up sharply has been coming down despite rising debt. During this period, profitability and as a consequence, the debt-servicing capacity of companies has, seen a decline. These trends may be indicative of halted projects, rising debt levels per unit of capex, overall rise in debt burden with poor recoveries on resources employed.”
What the central bank does not say is that rising debt without a rising capital expenditure may also be indicative of the fact that newer loans are being taken on in order to pay off older loans as well as pay interest on the outstanding loans. The public sector banks are issuing newer loans because if they don’t corporates will start defaulting and the total amount of bad loans will go up even further.
In such a scenario, the public sector banks have also been helping corporates by restructuring more and more loans. By doing this they are essentially postponing the problem. A restructured loan is not a bad loan. Further, around 40% of restructured loans between 2011 and 2014 have turned into bad loans.
All this hints towards a large section of Indian corporates operating in what Minsky referred to as a Ponzi stage of finance. Many corporates are also in the speculative stage. And given that, it’s not going to end well.
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)
A few days back sections of the media reported that Vijay Mallya, a part-time businessman and a full-time defaulter of bank loans, had celebrated his sixtieth birthday by throwing a huge party at the Kingfisher Villa in Candolim, Goa.
As the Mumbai Mirror reported: “International pop icon Enrique Iglesias belted out his 2014 chartbuster ‘Bailando’ (Dancing) hours after Sonu Nigam completed a nonstop two-hour session with ‘Tum jiyo hazaron saal, saal ke din ho pachaas hazaar’.”
This is while banks wait to recover thousands of crore of loans that Mallya has defaulted on, in his quest to own and run an airline.
While Mallya and other industrialists continue to have a good time, the bad loans of banks continue piling up. The Mid-Year Economic Analysis released by the ministry of finance last week points out towards the same. As it points out: “Gross Non Performing Assets (NPAs) of scheduled commercial banks, especially Public Sector Banks (PSBs) have shown an increase during recent years.”
The total bad loans (gross non-performing assets) of scheduled commercial banks increased to 5.14 % of total advances as on September 30, 2015. The number had stood at 4.6% of total advances, as on March 31, 2015. This means a jump of 54 basis points in a period of just six months. One basis point is one hundredth of a percentage.
The situation is much worse in public sector banks. The total bad loans of public sector banks stood at 6.21% of total advances as of September 30, 2015. This number had stood at 5.43% as on March 31, 2015. This is a huge jump of 78 basis points, within a short period of six months. The number had been at 4.72% as on March 31, 2014. This tells us very clearly that the bad loans situation of public sector banks has clearly worsened.
In fact, we get the real picture if we look at the stressed assets of public sector banks. The stressed asset number is obtained by adding the bad loans and the restructured assets of a bank. A restructured asset is an asset on which the interest rate charged by the bank to the borrower has been lowered. Or the borrower has been given more time to repay the loan i.e. the tenure of the loan has been increased. In both cases the bank has to bear a loss.
The stressed assets of the public sector banks as on September 30, 2015, stood at 14.2% of the total advances. Hence, for every Rs 100 of loans given by public sector banks, Rs 14.2 are currently in dodgy territory. In March 2015, the stressed assets ratio was at 13.15%. This is a significant jump of 105 basis points. In fact, if we look at older data there are other inferences that we can draw.
In March 2011, the number was at 6.6%. In March 2012, the number grew to 8.8%. And now it stands at 14.2%. What does this tell us? It tells us very clearly that banks are increasingly restructuring more and more of their loans and pushing up the stressed asset ratio in the process. And that is not a good thing. The banks are essentially kicking the can down the road in the hope of avoiding to have to recognise bad loans as of now.
In a research note published earlier this year, Crisil Research estimates that 40% of the loans restructured during 2011-2014 have become bad loans. Morgan Stanley estimates that 65% of restructured loans will turn bad in the time to come. What this tells us very clearly tells us that a major portion of stressed assets are essentially restructured loans which haven’t been recognised as bad loans.
This clearly tells us that the balance sheets of public sector banks continue to remain stressed. Data from the Indian Banks’ Association shows that the public sector banks own a total of 77.4% of assets of the total banking system. This means they dominate the system. And if their balance sheets are in a bad shape it is but natural that they will go slow on giving ‘new’ loans. As the latest RBI Annual Report points out: “Private sector banks with lower NPA ratios, posted higher credit growth …At the aggregate level, the NPA ratio and credit growth exhibited a statistically significant negative correlation of 0.8, based on quarterly data since 2010-11.” As the accompanying chart clearly points out the loan growth of private sector banks which have a lower amount of stressed assets has been much faster than that of public sector banks. Source: RBI Annual Report
Also, it is worth asking here why are public sector banks continuing to pile up bad loans. The answer might perhaps lie in the fact that the interest paying capacity and the principal repaying capacity of corporates who have taken on these loans continues to remain weak. As the Mid-Year Economic Review points out: “Corporate balance sheets remain highly stressed. According to analysis done by Credit Suisse, for non – financial corporate sector (based on ~ 11000 companies in the CMIE database as of FY2014 and projections done for FY2015 based on a sample of 3700 companies), the number of companies whose interest cover is less than 1 has not declined significantly (this number was 1003 in September 2014 and is 994 in September 2015 quarter).”
Interest coverage ratio is arrived at by dividing the operating profit (earnings before interest and taxes) of a company by the total amount of interest that a company needs to pay on what it has borrowed during a given period. An interest coverage ratio of less than one, as is the case with many companies in the Credit Suisse sample, essentially means that the companies are not making enough money to even be able to pay interest on their borrowings.
Further, “the weighted average interest cover ratio has declined from 2.5 in September 2014 to 2.3 in September 2015 (research indicates that an interest cover of below 2.5 for larger companies and below 4 for smaller companies is considered below investment grade).”
Given this, it is not surprising that bad loans of banks continue to pile up, while guys like Mallya continue to have a “good time”.
Postscript: I will be taking a break from writing The Daily Reckoning for the next few days. Will see you again in the new year. Here is wishing you a Merry Christmas and a very Happy New Year.
In the last monetary policy statement released by the Reserve Bank of India(RBI) on December 1, 2015, the governor Raghuram Rajan had said: “Since the rate reduction cycle that commenced in January , less than half of the cumulative policy repo rate reduction of 125 basis points [one basis point is one hundredth of a percentage] has been transmitted by banks. The median base lending rate has declined only by 60 basis points.” Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.
What this means is that even though the Rajan led RBI has cut the repo rate by 125 basis points, banks in turn have cut their lending rate by only around 60 basis points on an average. This clearly tells us is that the monetary policy of the RBI (or the process of setting interest rates) has only been half effective.
Why is that the case? A major reason for this lies in the way the banks calculate their base rate or the minimum interest rate that a bank can charge its customers. How is this base rate calculated? As the RBI Draft Guidelines on Transmission of Monetary Policy Rates to Banks’ Lending Rates released earlier this year pointed out: “At present, banks follow different methodologies for computing their Base Rate. While some use the average cost of funds method, some have adopted the marginal cost of funds while others use the blended cost of funds (liabilities) method. It was observed that Base Rates based on marginal cost of funds are more sensitive to changes in the policy rates.”
What does this statement mean? Some banks follow the average cost of funds method to decide on the base rate of their lending. The average cost of funds is the average interest rate that a bank pays on the fixed deposits and other borrowings that it raises. In this scenario if the average cost of funds of the bank is high, a cut in the repo rate is not going to lead to a similar cut in the base rate of the bank.
Hence, even if the RBI cuts the repo rate, the chances of the bank passing on a similar interest rate cut to its prospective borrowers remains low. The trouble here is that banks do go ahead and cut their deposit rates without cutting their lending rates. Hence, they pay a lower rate of interest rate on their deposits but continue to charge a higher rate of interest on their loans. They make more money in the process. Over the last few years, the public sector banks have piled up a lot of bad loans and it has been interest to cut deposit rates without cutting lending rates. It also leads to a situation where the RBI repo rate cut does not percolate through the financial system, making the monetary policy only partially effective.
On the other hand, some banks use the marginal cost of funds to decide on their base rate. The RBI found that banks which used this method where much more faster in cutting interest rates on their loans. Marginal cost of funds is essentially the interest rate that a bank pays on its new deposits as well as other borrowings.
As the RBI Draft Guidelines referred to earlier point out: “The marginal cost should be arrived at by taking into consideration all sources of fund other than equity. Cost of deposits should be calculated using the latest interest rate/card rate payable on current and savings deposits and the term deposits of various maturities. Cost of borrowings should be arrived at using the average rates at which funds were raised in the last one month preceding the date of review. Each of these rates should be weighted by the proportionate balance outstanding on the date of review.”
In a release last week, the RBI said that from April 1, 2016 onwards it wants all banks to follow the marginal cost of funding method to decide on their base rate. This means that if the banks cut their deposit rate in the aftermath of a RBI repo rate cut, they will have to cut their lending rates as well, because their marginal cost of funding will automatically fall. By doing this the RBI has essentially ensured that new borrowers of the bank will have access to lower interest rates automatically once the bank decides to cut its deposit rates.
Further, banks cannot lend below the marginal cost of funds based lending rate. This rate needs to be declared every month on a given date, though during the first year banks have been allowed to declare this rate once every three months.
Also, banks have been asked to declare a marginal cost of funds based lending rate for overnight loans, one-month, three-months, six-months and one-year loan. The banks have been given the option of publishing the marginal costs of funds based lending rate of maturities longer than one year as well.
What this means is that the banks now have the opportunity of matching their loans with their deposits. Hence, a loan being given out for a period of one year can be given out at the marginal rate of interest that the bank pays on a deposit (or any other borrowing) for a one- year period plus a certain spread over and above it.
As R.K. Bansal, executive director at IDBI Bank Ltd told Mint: “The differentiation based on tenor will be a big positive for banks as now we would be able to price our loans based on the deposits of the corresponding tenor, rather than the older practice of considering 3-6 month deposit rate for computing base rates for all loans.” Following this process banks can now largely avoid the asset-liability mismatch between their loans and their deposits, that they used to get into earlier.
How will this work for new borrowers? They will pay the rate of interest determined by the marginal cost of funds method until the date of the next reset. The reset date has to be one year or lower and has to be a part of the loan contract.
And how will this work for old borrowers i.e. those who have already borrowed from the bank under the old base rate regime? In this case, the borrowers will continue to pay their EMIs as they have been during the past. The banks will keep publishing the base rate as per the old method. In fact, old borrowers have an option of moving “to the Marginal Cost of Funds based Lending Rate (MCLR) linked loan at mutually acceptable terms.” The RBI has asked the banks not to treat this as a foreclosure of existing facility.
This methodology is expected to help banks to react faster to the repo rate cuts by the RBI by passing on similar interest rate cuts on their lending to new borrowers. In fact, once banks move on to this new way of calculating lending rates, new borrowers are likely to pay a lower rate of interest on their loans, in comparison to what they currently are.
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)
It’s too early to be writing about the next year’s budget as it’s more than two months away. But given the way things stand as of now a few things can be safely said.
The finance minister Arun Jaitley during the course of the budget speech in February earlier this year, had said: “I want to underscore that my government still remains firm on achieving the medium term target of 3% of GDP…I will complete the journey to a fiscal deficit of 3% in 3 years, rather than the two years envisaged previously. Thus, for the next three years, my targets are: 3.9%, for 2015-16; 3.5% for 2016-17; and, 3.0% for 2017-18.” Fiscal deficit is essentially the difference between what a government earns and what it spends.
The way things stand as of now there is no way that the finance minister can work with a fiscal deficit target of 3.5% of the gross domestic product(GDP) for 2016-2017, which is the next financial year.
Why do I say that? The Mid-Year Economic Analysis released by the ministry of finance last week hints towards the same. The nominal GDP growth for the first six months of the year came in only at 8.2%. It had been assumed to grow at 11.5% in the budget. Nominal GDP is essentially GDP which hasn’t been adjusted for inflation.
This lower than expected economic growth has led to the ministry revising the expected nominal growth for 2015-2016 to 8.2%. “Unless oil prices decline further this annual estimate of 8.2 percent would represent two successive years of substantial declines in nominal GDP growth…We estimate that real GDP for the year as a whole will lie in the 7-7.5 per cent range.,” the Mid-Year Economic Review pointed out. The real GDP is essentially GDP which has been adjusted for inflation.
In this scenario of lower than expected economic growth (as measured by the real/nominal GDP growth) “if the government sticks to the path for fiscal consolidation, that would further detract from demand,” the Review points out. Further, “consolidation of the magnitude contemplated by the government… could weaken a softening economy”. Fiscal consolidation is essentially the reduction of fiscal deficit, along the lines Jaitley had talked about in his budget speech.
What the Review is essentially saying here is that if the government continues to cut its fiscal deficit, it will have to cut down on its expenditure. And in an environment where the consumer and industrial demand isn’t really robust this may not be the best way to go about it. With overall demand not in best shape if the government also cuts its expenditure there will be a further fall in demand and in the process economic growth will slow down further.
Hence, enough hints have been dropped in the Mid-Year Economic Review to suggest that the government doesn’t plan to stick to the fiscal deficit target of 3.5% of the GDP in 2016-2017, as it had talked about at the time it presented the budget for 2015-2016.
In fact, even without taking what the Mid-Year Economic Review has to say, the numbers clearly suggest that there is no way the government can work with a fiscal deficit target of 3.5% of the GDP.
The recommendations of the Seventh Pay Commission are expected to add Rs 73,650 crore or 0.65% of the GDP in the first year, to the government’s expenditure. In line with the recommendations of the Commission, the government will pay higher salaries as well as pensions.
Also, the recommendations of the Commission come into effect from January 1, 2016. They will be implemented from April 1, 2016. Hence, arrears for the three months of January to March 2016 will also have to be paid. This is likely to amount to Rs 18,412.5 crore (Rs 73,650 divided by 4). This pushes up the total extra expenditure due to the recommendations of the Seventh Pay Commission to Rs 92,062.5 crore (Rs 73,650 crore plus Rs 18,412.5 crore).
Over and above this, The Financial Express reports that the Railways has requested the government to fund the extra money it would have to spend in order to meet the recommendations of the Seventh Pay Commission. This is estimated to be Rs 28,450 crore. The Pay Commission in its reports expected the Railways to meet this extra expenditure out of its own revenues. But with the revenues of the Railways not growing as fast as they were expected to, this may not happen now.
Further, arrears of the first three months of 2016 will also have to be paid by the Railways and this will push the total extra expenditure of the Railways to be funded by the government to Rs 35,562.5 crore (Rs 28,450 crore plus Rs28,450 crore divided by 4).
Hence, the total extra expenditure of the government due to the recommendations of the Seventh Pay Commission will come to Rs 1,27,625 crore (Rs 92,062.5 crore plus Rs 35,562.5 crore). Add to this the extra expenditure due to the implementation of one rank one pension which is expected to come to Rs 10,000 crore and we are looking at an extra expenditure of close to Rs 1,40,000 crore.
Also, as I had pointed out in yesterday’s column food and fertilizer subsidies of greater than Rs 1,00,000 crore have not been paid. Once all these factors are taken into account it becomes very clear that there is no way the government can come up with a fiscal deficit number of 3.5% of the GDP.
So, what is the solution for the government, given that this is big money being talked about here? Rest assured some accounting shenanigans will be resorted to with some expenditures (like the payment of subsidies) being postponed. Over and above this, the government needs to shut down loss making public sector enterprises and sell the assets these public sector enterprises have been sitting on for many years now.
The Business Standard reports that the government is planning to raise the rate of service tax from the current 14% to 16%. This is line with the recommendations of the Arvind Subramnian committee which has proposed a standard goods and services tax in the range of 16.9-18.9%. As an editorial in The Financial Express points out: “Based on this year’s budgeted collections for service taxes, a 2-percentage-point hike can yield around R30,000-35,000 crore extra.” And this clearly won’t be enough.