Tag: Fiscal Deficit | Page 3

1 March, 2016

Jaitley’s Fiscal Deficit Numbers Don’t Really Add Up

Dear Reader,

By the time you read this piece, you would have been bombarded with a huge amount of analysis on the budget the finance minister Arun Jaitley presented yesterday.

Nevertheless, most such analysis misses out on carefully looking at the fiscal deficit number, which is basically what the budget is all about. Most other things that finance ministers talk about in their budget speeches, they can talk about on any other day of the year as well.

In fact, regular readers would know that I have been sceptical about the ability of the government to meet its fiscal deficit target. Fiscal deficit is the difference between what a government earns and what it spends during the course of any year. The difference is met through borrowing.

While presenting the budget last year, the finance minister Jaitley had said that the government expects to achieve a fiscal deficit target of 3.5% of GDP for 2016-2017 and 3% of GDP for 2017-2018.

In the budget presented yesterday Jaitley said that: “I have weighed the policy options

and decided that prudence lies in adhering to the fiscal targets. Consequently, the fiscal deficit in RE[revised estimate] 2015-16 and BE[budget estimate] 2016-17 have been retained at 3.9% and 3.5% of GDP respectively.”
The question is how realistic is the 3.5% of GDP fiscal deficit target for the next financial year? There are essentially three inputs that go into making the fiscal deficit number. The total receipts of the government, the total expenditure of the government and the nominal GDP number that has been assumed for the next financial year. Nominal GDP is the GDP which hasn’t been adjusted for inflation.

Let’s start with the receipts number. Jaitley has assumed that the government plans to collect Rs 56,500 crore through the disinvestment route. Of this, Rs 36,000 crore will come from the government selling shares in the companies its own and Rs 20,500 crore from the stakes that it has in non-government companies.

The total number assumed to come in through the disinvestment route is more than double of the Rs 25,312 crore that the government collected through the route this financial year. It needs to be pointed out here that a substantial part of this came from the Life Insurance Corporation(LIC) of India picking up stakes in government owned companies. Honestly that can’t be called disinvestment. It is money moving from one arm of the government to another.

Second, last year the government had assumed that Rs 69,500 crore would come in through disinvestment. Ultimately, only Rs 25,312 crore has been collected and that also after LIC had to come to the rescue. One excuse offered for the government going slow on disinvestment was low commodity prices. Commodity prices continue to remain low.

Given this, the Rs 56,500 crore disinvestment number is an overestimate like was the case last year as well.

The government has also assumed that it will earn Rs 98,994.93 crore from the telecom sector. This receipt comes under the entry “other communication services” and is primarily the money the government will earn through telecom spectrum auctions. Again, like is the case with disinvestment receipts, this number is a huge jump from the Rs 57,383.89 crore that the government managed to collect this year.

Given, the past record of the government, these assumptions are clearly looking overoptimistic. Also, they help in under-declaring the fiscal deficit. As per IMF norms, any kind of asset sales by the government needs to be treated as a financing item and not as a receipt as the Indian government does. In the process the government manages to come up with a lower fiscal deficit number.

Now let’s take a look at the expenditure front. There is no clarity on how much allocation the government has made towards implementing the recommendations of the Seventh Pay Commission. As Jaitley said during his speech: “the Seventh Central Pay Commission has submitted its Report. Following the past practice, a Committee has been constituted to examine the Report and give its recommendations. In the meantime, I have made necessary interim provisions in the Budget.”

The finance minister didn’t get into any more details. Nevertheless, one can use the numbers given in the budget and see if the right kind of allocation has been made. During 2015-2016, the government’s salary and pension bill (excluding Railways) is expected to be at Rs 1.85 lakh crore.

In 2016-2017, the government’s salary and pension bill has been budgeted at around Rs 2.25 lakh crore. This is Rs 40,000 crore more than the 2015-2016 number.

The Seventh Pay Commission recommendations come into force from January 1, 2016. The Seventh Finance Commission had said that its recommendations would cost the government Rs 73,650 crore during the first year. To this one would have add the cost of Pay Commission recommendations between January and March 2016, which would be needed to be paid as arrears to the government employees and pensioners.

This works out to Rs 18,412.5 crore (Rs 73,650 crore divided by four). Hence, the total extra allocation towards implementing the recommendations of the Seventh Pay Commission should have been around Rs 92,000 crore (Rs 74,650 crore plus Rs 18,412.5 crore). The actual increase in allocation towards salaries and pensions is only around Rs 40,000 crore.

What does this tell us? The government is probably not in the mood to pass on the entire increase in salaries and pensions during the course of 2016-2017. If it does that, then it will have to pay arrears in the years to come and that will add to the government expenditure and hence, the fiscal deficit. So to that extent the fiscal deficit is being under-declared at this moment.

Also, the implementation of one rank one pension in the defence forces is expected to push the pension bill up, by Rs 10,000 crore. And that will also add to the salary and the pension bill of the government.

Further, as I have pointed out in the past, more than Rs 1,00,000 crore of food and fertilizer subsidy bills remain unpaid. And that is how it continues to be. The allocation to food and fertilizer subsidy has fallen from Rs 2.12 lakh crore in 2015-2016 to Rs 2.05 lakh crore in 2016-2017.

What does this mean? It means that while the government will pay the Rs 1,00,000 lakh crore of pending food and fertilizer subsidy bills, it will then have to postpone paying a large part of the food and fertilizer subsidy expenditure that is incurred during the next financial year.

The government follows the cash accounting system and only acknowledges expenses once payment has been made. This has led to a situation where subsidy payments to Food Corporation of India(FCI) and fertilizer companies remain unpaid. The money has been spent by FCI and the fertilizer companies towards subsidy, but remains unpaid by the government, and hence is not acknowledged as an expenditure.

The question is where does FCI get this money from? It borrows from the financial market. Why does the market lend money to FCI? It does that because it knows that it is effectively lending money to the Indian government. Hence, this subsidy expenditure has already been incurred by the government but has not been accounted for.

This essentially leads to a lower fiscal deficit number. Further, the absolute fiscal deficit number of Rs 5,33,904 crore looks very unrealistic given that the receipts of the government have been overstated while the expenditure has been understated.

Now let’s talk about the denominator in the fiscal deficit number, the nominal GDP. The nominal GDP for 2016-2017 has been assumed to be at Rs 15,065,010 crore assuming 11% growth over the 2015-2016 number. How realistic is this assumption? In 2015-2016, the nominal GDP is expected to grow at 8.6%. Given this, how realistic is an assumption of 11% nominal GDP growth for 2016-2017?

To conclude, it is safe to say that Jaitley’s fiscal deficit number is not believable. As the American professor Aaron Levenstein once said: “Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital.”

What Jaitley has managed to conceal is vital.

The column originally appeared on the Vivek Kaul Diary on March 1, 2016

9 February, 2016

What the GDP numbers tell us about the fiscal deficit

The Central Statistics Office(CSO) has published the economic growth numbers for the period October to December 2015. It has also put out the economic growth projection for the current financial year i.e. 2015-2016 (April 1, 2015 to March 31, 2016).

The Indian economy grew by 7.3% during the period October to December 2015. It is projected to grow at 7.6% during 2015-2016. Economic growth is measured by the growth in the gross domestic product(GDP). But GDP is a theoretical construct. There are many high frequency economic data indicators which tell us very clearly that there is no way that the country is growing at the rate at which the government wants us to believe it is.

Much has been written about the fact that India’s economic growth numbers can’t be possibly right and given that I wanted to discuss something else, but equally important in this column.

The GDP growth is declared in several forms. When CSO talks about the Indian economy growing by 7.6%, during the course of the year, it is talking about real GDP growth. Real GDP growth is essentially adjusted for inflation. The economic growth which is not adjusted for inflation is known as the nominal GDP growth. The nominal GDP growth for the current financial year is expected to be at 8.6%. Typically, the difference between nominal and real GDP growth is greater than this.

When calculating the fiscal deficit, the government uses the nominal GDP. This is because the revenue as well as the expenditure of the government are not adjusted for the prevailing inflation. Fiscal deficit is the difference between what a government earns and what it spends during the course of the year.

When the finance minister Arun Jaitley presented the budget in last February, he had set a fiscal deficit target of 3.9% of the GDP. The GDP here is the nominal GDP. There are essentially two numbers in the fiscal deficit calculation—the absolute fiscal deficit number and the nominal GDP number.

The absolute fiscal deficit number for this year was set at Rs 5,55,649 crore. The nominal GDP number in the budget was assumed to be at Rs 14,108,945 crore. It was assumed that the nominal GDP would grow by 11.5% in comparison to the nominal GDP in 2014-2015, which was at Rs 12,653,762 crore.

The growth of 11.5% in nominal GDP has not materialised and now close to the end of this financial year, the government thinks that the nominal GDP growth will be at a much lower 8.6%. And this is precisely what has upset the fiscal deficit calculations of the government. A growth of 8.6% means that the nominal GDP for 2015-2016 will come in at Rs 13,741,986 crore.

If the government maintains an absolute fiscal deficit of Rs 5,55,649 crore, then the fiscal deficit as a proportion of the nominal GDP will come in at 4.04% of the GDP. In order to maintain the fiscal deficit at 3.9% of the GDP, the government will have to cut down the fiscal deficit by around Rs 20,000 crore, assuming all other projections remain the same.

A fiscal deficit of 4.04% of the GDP is higher than 3.90% of the GDP, but not significantly higher. But that is not what has got the government worrying. In fact, the finance minister Arun Jaitley had talked about fiscal consolidation in the two budget speeches he has made till date in July 2014 and February 2015. Fiscal consolidation is the reduction of the fiscal deficit.

In July 2014 Jaitley had said: “We need to introduce fiscal prudence that will lead to fiscal consolidation and discipline. Fiscal prudence to me is of paramount importance because of considerations of inter-generational equity. We cannot leave behind a legacy of debt for our future generations. We cannot go on spending today which would be financed by taxation at a future date.”

He had further said: “One fails only when one stops trying. My Road map for fiscal consolidation is a fiscal deficit of 3.6 per cent [of the GDP] for 2015-16 and 3 per cent for 2016-17.”

In the speech he made in February 2015, he postponed this target by a year and said that the government will achieve a fiscal deficit of 3.5% of GDP in 2016-17; and 3% of GDP in 2017-18.

The point being that the government had originally envisaged achieving a fiscal deficit of 3.6% of GDP during this financial year. This target was postponed by a year and the government set itself a much easier target of 3.9% of GDP. And given this, it is very important that the government achieve this much easier target, if it wants people to take it seriously in the future on the fiscal deficit front.

Further, it is worth pointing out here that typically if the government were to follow the international norms of declaring the fiscal deficit and not include disinvestment proceeds as a revenue item but a financing item, the fiscal deficit for 2015-2016 would be at 4.4% of the GDP. Also, the 3.9% of GDP fiscal deficit target does not include subsidy payments of more than Rs 1,00,000 crore that need to be made for fertilizer and food subsidies.

The government can achieve a 3.9% of GDP fiscal deficit target, by increasing its revenue and cutting down on its expenditure. The government has been trying to increase its revenue by increasing the excise duty on petrol and diesel. Three such hikes have been made since January 2016. This has led to a situation where oil prices have fallen dramatically but petrol and diesel prices in India have actually risen over the last one year.

The petrol price in Mumbai as of now is Rs 66.05 per litre. The price as of last February was at Rs 63.9 per litre. The price of the Indian basket of crude oil during the same period has fallen by more than 44%.

While the government continues to raise the excise duty on petrol and diesel, it continues to own a 11.2% stake in cigarette maker ITC. This stake as of yesterday’s closing price was worth Rs 28,256 crore. What is so strategic about owning a stake in a cigarette company and at the same time run advertisements trying to tell the country at large that it consumption of tobacco is injurious to health? Why can’t this stake be sold and the money used for better purposes?

This is something that the government needs to explain.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on February 9, 2016.

8 February, 2016

Mr Jaitley’s Search for a One-Handed Economist

“Give me a one-handed economist,” quipped the American president Harry Truman, many years back. “All my economists say, ‘on the one hand…on the other’.”

The finance minister Arun Jaitley is currently probably going through the one-handed economist phase as well. There has been a huge debate going on, in the media, whether the government should relax the fiscal deficit target of 3.5% of gross domestic product for the next financial year i.e. 2016-2017, when it presents its budget later this month. Fiscal deficit is the difference between what a government earns and what it spends.

Economists, as usual, are divided on it. Some like the idea of government spending more in order to revive the slow economic growth (or so they like to believe). Others have been highlighting the negative consequences of the government spending more.

This has left Jaitley, who has no background in either finance or economics, and was a part-time politician and a full-time layer, until few years back, confused. As he recently said: “I’ve been consulting all shades of opinion. This is the first time I’ve come across people holding sharply divided views. Each one has a strong argument in his favour.”

The Chief Economic Adviser to the finance ministry, Arvind Subramanian, has been in favour of the government spending more. In the Mid-Year Economic Analysis released in December 2015, Subrmanian had suggested that in a 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.” Further, “consolidation of the magnitude contemplated by the government… could weaken a softening economy”. Fiscal consolidation is essentially the reduction of fiscal deficit.

The finance minister Arun Jaitley had talked about fiscal consolidation in the two budget speeches he has made till date in July 2014 and February 2015. In the first speech he said that the government is aiming to achieve a fiscal deficit target of 3% of gross domestic product(GDP) in 2016-2017.

In the speech he made in February 2015, he postponed this target by a year and said that the government will achieve a fiscal deficit of 3.5% of GDP in 2016-17; and 3% of GDP in 2017-18. Now there is pressure on the finance minister to abandon the fiscal deficit target of 3.5% of the GDP set for 2016-2017, from one set of economists and the industry.

The trouble is another set of economists does not agree with this. Economist Arvind Panagariya, who happens to be the vice chairman of the NITI Aayog said in January 2016: “I personally don’t think we should be tinkering with the deficit as a percentage of GDP.”
Raghuram Rajan, the governor of the Reserve Bank of India, has also been an advocate of the government sticking to a path of fiscal consolidation. He reiterated the same in a recent speech as well as the monetary policy statement released last week.

One of the interesting points that Rajan made was that India’s overall fiscal deficit position has deteriorated. As he said: “The consolidated fiscal deficit of the state and centre in India is by far the largest among countries we like to compare ourselves with; presently only Brazil, a country in difficulty, rivals us on this measure. According to IMF estimates (which is what the global investor sees), our consolidated fiscal deficit went up from 7 percent in 2014 to 7.2 percent in 2015. So we actually expanded the aggregate deficit in the last calendar year. With UDAY, the scheme to revive state power distribution companies, coming into operation in the next fiscal, it is unlikely that states will be shrinking their deficits, which puts pressure on the centre to adjust more.”

One reason why government’s numbers are different from IMF numbers is because the government of India under-declares its fiscal deficit. How does it do it? The government recognises the disinvestment of shares in public sector units as a revenue rather than as a financing item.

As economist Rajeev Malik of CLSA put it in a recent column in the Mint: “India tends to under-report its fiscal deficit because it counts divestment and other asset sales as revenue rather than a financing item, as is practised by the International Monetary Fund (IMF). Thus, the FY16 budget deficit target—adjusted for divestment—was actually 4.4% of GDP, not 3.9% as officially reported.”

“Rating agencies remain strangely silent on this self-serving approach,” Malik validly points out.

What complicates the situation further is that the government follows the cash accounting system and only acknowledges expenses once payment has been made. This has led to a situation where subsidy payments to Food Corporation of India(FCI) and fertilizer companies remain unpaid. The money has been spent by FCI and the fertilizer companies but remains unpaid by the government, and hence is not acknowledged as an expenditure.

As economist M Govinda Rao put it in a recent column in The Financial Express: “In fact, the cash accounting system hides the real fiscal deficit which is much higher as substantial subsidy payments to Food Corporation of India and fertiliser companies are yet to be disbursed.”

While Jaitley may keep debating whether or not to abandon the fiscal deficit target that he set previously, he needs to tell us clearly what is India’s real fiscal deficit. If that means that he doesn’t get around to meeting the target.

Getting back to Rajan, the RBI governor also raised the question, whether the extra economic growth that will come in because of the government abandoning its fiscal deficit target and spending more, be worth it.

As Rajan said: “Perhaps Brazil offers a salutary lesson. Only a few years ago, the world was applauding the country’s thriving democracy, its robust economic growth, and the enormous strides it was making in reducing inequality. It grew at 7.6 percent in 2010…Paradoxical as it may seem, Brazil tried to grow too fast. The 7.6 percent growth came on the back of substantial stimulus after the global financial crisis.”

In fact, India tried the same strategy in the aftermath of the financial crisis, with the government coming up with a substantial economic stimulus. While this lifted the economic growth for the next few years, it led to a huge increase in corporate debt and high inflation, the aftermaths of which the country is still facing.

The column originally appeared in the Vivek Kaul Diary on Equitymaster on February 8, 2016

12 January, 2016

Of Jaitley, Fiscal Deficit and a 19th Century French Economist

Lawyers who become politicians are extremely eloquent speakers. But do they ‘really’ mean what they say? Or is it just something that sounds good at a given point of time, like a film dialogue?

The finance minister Arun Jaitley in his maiden budget speech in July 2014 had said: “We need to introduce fiscal prudence that will lead to fiscal consolidation and discipline. Fiscal prudence to me is of paramount importance because of considerations of inter-generational equity. We cannot leave behind a legacy of debt for our future generations. We cannot go on spending today which would be financed by taxation at a future date.”

Most governments spend more than what they earn. In order to bridge the gap, they borrow money by selling governments bonds. These bonds are repaid in the years to come. If the government borrows more today, the more it has to repay in the years to come.

This repayment is carried out of the money the government earns from taxing the future generations. This means that the benefits of borrowing are received by one generation but the debt is repaid by another. And this is why Jaitley talked about “considerations of inter-generational equity”. Or so it seemed.

The only way of respecting inter-generational equity is to borrow less today, so that the future generations don’t have to repay it, in the days to come. Borrowing less is only possible if the government is spending less today.

In his July 2014 budget speech Jaitley had talked about precisely this. He had said: “Difficult, as it may appear, I have decided to accept this target as a challenge. One fails only when one stops trying. My Road map for fiscal consolidation is a fiscal deficit of 3.6 per cent [of the gross domestic product (GDP)] for 2015-16 and 3 per cent for 2016-17.”

Fiscal deficit is the difference between what a government earns and what it spends. This difference is made up through borrowing money by selling government bonds. Hence, a lower fiscal deficit means lower borrowing and in the process the “considerations of inter-generational” equity is take into account.

In the budget speech Jaitley made in February 2015, the considerations of inter-generational equity took a slight backseat. He postponed the achievement of the fiscal deficit target of 3% of the GDP for 2016-2017, by a year.

As he said on that occasion: “Rushing into, or insisting on, a pre-set time-table for fiscal consolidation pro-cyclically would, in my opinion, not be pro-growth. With the economy improving, the pressure for accelerated fiscal consolidation too has decreased. In these circumstances, 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. The additional fiscal space will go towards funding infrastructure investment.”

What the government had set out to achieve in a period of two financial years, Jaitley said would now be achieved in three years. This was in February 2015, when the budget for the current financial year 2015-2016 was presented.

In the recent past, there have been news-reports as well as statements which suggest that the government will again postpone, the fiscal deficit targets it had set for itself. “I am not particularly worried about the fiscal deficit target,” Jaitley said in early December.

A Reuters news-report quotes a senior finance ministry official as saying that the “the minister[i.e. Jaitley] has been advised to increase its fiscal deficit target to 3.7 or 3.9 per cent of gross domestic product (GDP) from 3.5 per cent.” “The economy is still suffering from slack demand…It needs a conducive fiscal and monetary policy,” the official added.

The industrial as well as consumer demand are seeing slow-growth and hence the government should be spending more, and in the process incurring a higher expenditure and a higher fiscal deficit. The higher government expenditure will push up economic growth. This is what the senior finance ministry official meant.

This is something Jaitley has also said recently: “Public investment has been stepped up in the last year and it will continue to remain stepped up… When you fight a global slowdown, public investment has to lead the way.”

In a year when the government will have to incur significantly extra expenditure to implement the recommendations of the Seventh Pay Commission, implement one rank one pension for the armed forces and pay pending, fertilizer and food subsidies, where is the money for public investment going to come from?

It is worth recounting here what the French economist Frédéric Bastiat had said in his 1874 book That Which is Seen, and That Which is Not Seen. “In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause–it is seen. The others unfold in succession—they are not seen. It is well for us if they are foreseen.”

When we talk about the government abandoning the fiscal deficit target and spending more, this is precisely how things are playing out. The immediate effect or that which is seen is that higher government expenditure will create economic growth in an environment where industrial and consumer demand growth continues to remain slow. This is the effect that is being ‘seen’.

But there are other effects which are not being seen. The entire issue about inter-generational equity that Jaitley had talked about in his July 2014, seems to have taken a backseat.

Let’s go back a few years in order to understand this point. In 2008-2009, the government spent 51% of what it earned in paying interest on its existing debt and repaying the debt that was maturing. In the aftermath of the financial crisis that started in September 2008, the government increased its expenditure and its fiscal deficit. When the government talked about increased government spending it was only in the context of economic growth. This effect was seen.

Nevertheless, increased government spending meant more borrowing. In 2015-2016, the government will spend around 60% of what it earns in paying interest on existing debt and repaying the debt that matures. The higher borrowing of 2008-2009 and the years that followed is now having an impact. This was the effect which was unseen or wasn’t foreseen in 2008-2009, when the government decided to spend more. This is what Jaitley meant when he talked about considerations of inter-generational equity.

When one government borrows more it leaves a problem for another government in years to come. Also, as more money goes towards debt servicing it leaves little money for other things, unless more money is borrowed.

Further, the government doesn’t have any separate access to borrowings. As economist M Govinda Rao wrote in a recent column in The Financial Express: “This year, the Union government’s deficit is set at 3.9%, and with the states together having a deficit of about 2.2%, the aggregate fiscal deficit of the government works out to 6.1%. It is reported that 21 distribution companies are likely to join the UDAY scheme and the deficit on that account could be about 1%.” If we were to add all this the real fiscal deficit of the government would come at 7.1% of the GDP. The household financial savings in 2014-2015 stood at 7.5% of GDP.

This means that if the government borrows more it will automatically lead to higher interest rates for everyone else who wants to borrow. When the finance minister talks about public investment and not being bothered about a higher fiscal deficit, these points also need to be ‘seen’. Currently, they are not being seen.

As Bastiat put it: “Between a good and a bad economist this constitutes the whole difference—the one takes account of the visible effect; the other takes account both of the effects which are seen and also of those which it is necessary to foresee.”

Of course, politicians are in the business of winning elections not in the business of foreseeing or in the business of practicing good economics.

The column originally appeared on The Daily Reckoning on January 12, 2016

7 January, 2016

Mr Jaitely, Where Will The Money For Public Investment Come From?

On the last page of his magnum opus The General Theory of Employment, Interest and Money, the British economist John Maynard Keynes wrote: “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

One of the ideas of Keynes that has never become ‘defunct’ so to say, is that of governments needing to spend more when the economy is in trouble. In The General Theory, Keynes went to the extent of saying: “If the Treasury[i.e. the government] were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again … there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.”

How would this help in reviving the economy during bad times? Raj Patel explains this in The Value of Nothing as follows: “Keynes suggested, rhetorically, that if they lacked the imagination for anything more creative, governments could simply bury bottles of money under tons of trash, and that this would help get the economy going. It may sound bizarre, but it would certainly be worth someone’s while to dig up free money. To find these banknotes would require workers. Those workers would need to pay for food and shelter and everything else they needed to survive while they dug. The grocers who fed them and the landlords who rented to the workers would then have cash to spend, which they would use to buy other goods, and so on. This is called the “multiplier effect,” and it’s the added return that a government gets from spending its money in the economy.”

Keynes’ The General Theory was first published in 1936 and since then politicians all over the world have latched on to the idea of the government having to increase public spending when times are tough.

The finance minister Arun Jaitley is not different on this front. As he recently said: “Public investment has been stepped up in the last year and it will continue to remain stepped up… When you fight a global slowdown, public investment has to lead the way.”

In an environment where corporate balance sheets are stressed and public sector banks are in a mess, this might seem like the best way forward. But that is a very simplistic way of looking at things. The question is where will the money to pay for this public investment come from? And how will the government meet this expenditure and at the same time ensure that the fiscal deficit does not go up? Fiscal deficit is the difference between what a government earns and what it spends.

In the budget speech Jaitley made in February 2015, he had said: “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.”

From what it looks like, Jaitley is unlikely to meet the fiscal deficit target of 3.5% of the gross domestic product (GDP) in 2016-2017, the next financial year. In fact, the Mid-Year Economic Analysis released by the ministry of finance in December 2015 has hinted at this very clearly.
As the Economic Analysis points out: “If the government sticks to the path for fiscal consolidation, that would further detract from demand…[Fiscal] 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 this clearly tells us is that the government is more serious about public investment than meeting the fiscal deficit target. The question is where will the money to finance public investment come from? As I explain here, the total cost of implementing the recommendations of the Seventh Pay Commission and One Rank One Pension will come close to Rs 1,40,000 crore, if the Railways is not bailed out by the government. Over and above this, food and fertilizer subsidies of more than Rs 1,00,000 crore, continue to remain unpaid. This doesn’t leave much scope for public expenditure, unless the government leaves the subsidy bills unpaid.

Further, there are other things that need to be looked at. Take a look at the following table and the debt servicing ratio of the government.

Debt servicing is defined as the amount of money a government spends towards repaying the debt as well as paying interest on the outstanding debt. The debt servicing ratio is obtained by dividing the money spent towards debt servicing by the revenue receipts i.e. the income of the government. What the table clearly tells us is that the debt servicing ratio of the government has worsened over the years.

In 2015-2016, the government is expected to spend close to 60% of what it earns in servicing its debt. And this is clearly not healthy. Any further worsening of the fiscal deficit will only mean a greater amount of government revenues going towards servicing its past debt in the years to come. This will leave a lower amount of money for other more important things, in the years to come. Debt servicing is defined as the amount of money a government spends towards repaying the debt as well as paying interest on the outstanding debt. The debt servicing ratio is obtained by dividing the money spent towards debt servicing by the revenue receipts i.e. the income of the government. What the table clearly tells us is that the debt servicing ratio of the government has worsened over the years.

Also, most analysts and experts tend to just look at the fiscal deficit of the central government, without taking into account the fiscal deficits of the state governments as well. As economist M Govinda Rao wrote in a recent column in The Financial Express: “This year, the Union government’s deficit is set at 3.9%, and with the states together having a deficit of about 2.2%, the aggregate fiscal deficit of the government works out to 6.1%. It is reported that 21 distribution companies are likely to join the UDAY scheme and the deficit on that account could be about 1%.”

If we were to add all this the real fiscal deficit of the government would come at 7.1% of the GDP. The household financial savings in 2014-2015 stood at 7.5% of GDP. What this tells us very clearly is that the government captures most of the household financial savings. Any further increase in fiscal deficit leading to increased borrowing by the government will only push up interest rates. Also, Rao estimates that public sector enterprises claim around 2% of the GDP. Hence, as he asks “where can financial institutions find the money to lend for private investment?”

Over and above all these numbers the credibility of Arun Jaitley is at stake as well. In his maiden budget speech in July 2014 he had said: “We need to introduce fiscal prudence that will lead to fiscal consolidation and discipline. Fiscal prudence to me is of paramount importance because of considerations of inter-generational equity. We cannot leave behind a legacy of debt for our future generations. We cannot go on spending today which would be financed by taxation at a future date.”

In his February 2015 speech Jaitley went against what he had said earlier and loosened the fiscal strings a little. If he does that again this year, how much credibility would what he says, continue to have? Also, is Jaitley still worried about inter-generational equity? Or was what he said in July 2014 innocent murmurs of a new finance minister, which should not have been taken seriously?

Further, there has been very little effort on part of the government to take tough decisions on the expenditure front. It continues to fund loss making entities like MTNL, Air India etc. The finance ministry had set up the Expenditure Management Commission in 2014. The reports of the Commission have not been made public up until today. This clearly tells us how serious the government is about cutting wasteful expenditure.

Also, there has been very little new thinking on part of the government in order to increase its income. Even low hanging fruit like the stake the government holds in companies like ITC, L&T and Axis Bank, through the Specified Undertaking of Unit Trust of India (SUUTI)., hasn’t been cashed in on. All the government seems to be doing to increase its revenue is to increase the excise duty on petrol and diesel.

It is also worth asking why does the fastest going large economy in the world need a fiscal stimulus from the government?

To conclude, since I started this column with Keynes it is only fair that I end it with him as well. One of the misconceptions that people have is that Keynes was an advocate of the government running high fiscal deficits all the time. It needs to be clarified that his stated position was far from that.

Keynes believed that, on an average, the government budget should be balanced. This meant that during years of prosperity, governments should run budget surpluses. But when the economic environment is weak, governments should spend more than what they earn, and even run high fiscal deficits.

But over the decades, politicians have only taken one part of Keynes’ argument and run with it. The idea of running deficits during bad times has become permanently etched in their minds. However, they have forgotten that Keynes had also wanted them to run surpluses during good times as well.

Jaitley is a politician, he is no different from others of his ilk.

(The column originally appeared on SwarajyaMag on January 7, 2016)