Wrong bet on debt...?

Wrong bet on debt...?


Finance Minister: Pranab Mukherjee

One day after the Union Budget for the year 2009-10 was presented, the Finance Minister Pranab Mukherjee told industry representatives at a meeting organised in Delhi that he has taken a ‘calculated risk’ in the budget by keeping very high fiscal deficit. The gap of Rs 451,000 crore between the expenditure and income of the government, Mukherjee said, will be bridged with borrowings from financial system.

As a result, country’s fiscal deficit will rise to 6.8 per cent of the gross domestic products (GDP), three times of what it was three years ago. But Mukherjee was assertive that the government’s plan to spend big  with borrowed money will be good for the economy and it was a risk worth taking.

It is good to have a confident Finance Minister especially at a time when the economy is in a state of flux due to global recession. But probe deeper, you will find that the FM’s optimism is based on many assumptions which can go wrong. And if things do not happen the way the government expects, country’s fiscal management can go totally out of hand. There is also a strong possibility that India may get into a debt trap if the economy fails to revive. In fact, soon after the Budget presentation the FM admitted to a news channel “I have taken tremendous risk to create that fiscal space of having higher deficit.”

Betting on growth
Mukherjee’s revelation, expectedly, raised an alarm bell as many economic pundits predicted a fiscal disaster in the offing. Their main contention was that the doubling of the fiscal deficit will force the government to borrow more and print more money to meet expenses.

This in turn will lead to hyper-inflation in the economy within one year or so. Not a very pleasant scenario because barely a year ago India’s rate of inflation had peaked to 13 per cent.

But before we asses the risk, let us try to understand the compulsions that made FM take such a huge debt burden. The most important reason is that Indian economy has considerably slowed down in the last one year so, and the government’s strategy is to kick start it to return to growth path.

To reach the target of a 9 per cent growth in GDP in 2009-10, as against around 6.5 per cent in 2008-09, the Budget has set aside huge funds for spending on major infrastructure projects (rural and urban), employment guarantee schemes, social welfare schemes, loan waivers, defence etc. On infrastructure projects alone, for example, total spending in 2009-10 is expected to be Rs 124,000 crore, almost double of previous year.
Add up all — the total expenditure of the central government will touch Rs 10 trillion in 2009-10.  “We have enhanced the plan outlay in a big way to achieve the high growth trajectory,” said the FM in his post-budget interview. “We have to keep in mind, with the growing aspirations of the people, you cannot simply resort to strict monetary policy.”

Subsidy burden    
To partly bear the burden of the farmers and common man the government also provides subsidy on fertiliser, petrol, diesel, kerosene, LPG etc. Besides, to build up stocks of food grains for distribution through the fair price shops and to support farmers, the government also buys major food grains at the minimum support price. The subsidy provision for fertilisers in 2008-09, for example, was around Rs 95,000 crore. Similarly, the government had to spend Rs 78,000 crore on oil subsidy, including oil bonds to meet the shortfall of oil marketing companies. 

Shortfall in income
While the government’s spending is galloping, its income is dwindling. The biggest culprit, of course, is the recession that has hit the Indian economy from the middle of 2008.

Thanks to global economic recession India’s exports tumbled, foreign investments reduced to a trickle and hoards of money was pulled out of the capital market leading to crash in stock indices. Our growth in industrial production started slowing down from the third quarter of 2008. It went into the negative territory and has pulled back to positive in the last two months.

Naturally, the slowdown in economic activity curtailed sales of goods and services and the government’s revenue from taxes took a beating.

The central government in 2008-09, for example, is expected to earn total tax revenue of Rs 465,970 crore, a good 8 per cent lower than what it expected in the beginning of the year. No wonder, total tax revenue of the government (customs, excise, corporate and service tax) was just enough to foot 53 per cent of the government’s total expenditure of Rs 900,953 crore in 2008-09, the balance came from borrowing (34 per cent) and non-tax revenue (13 per cent).

Debt trap
Borrowing to pay for some of the bills for some time is not a bad economics if the borrowed money can generate accelerated income to pay up loans in the future. But it is terrible economics if borrowing keeps growing year after year, to sustain higher expenditure and also to pay for the interest on borrowed money. This is what economists call ‘Debt Trap’ a vicious cycle very difficult to breakout from.

Is India heading for debt trap? Yes, if the finance minister’s gamble to return to growth path does not pay up. As per the plan the government will borrow Rs 451,000 crore in 2009-10 almost one-and-half times of Rs 182,000 crore it borrowed in 2007-08. The immediate impact is the ballooning interest cost.

The interest outgo in 2009-10 is expected to reach Rs 225,511 crore as against Rs 192,694 crore in 2008-09 and Rs 171,030 crore in 2007-08. Interest payment is likely to account for 22 per cent of the government’s total expenditure in the current fiscal. Even worse is the fact that interest payment will eat up 37 per cent of the every rupee the government earns as revenue. Economists feel that such a huge interest burden is unsustainable in the long run unless the economy booms and tax receipts swell.

Crowding out the market
The government’s large borrowing plan has made the private sector borrowers jittery.

Along with state governments, total governmental borrowing in 2009-10 is expected to be around Rs 500,000 crore, accounting for three-fourth of the banking system’s total deposit of Rs 650,000 crore. After this the banking system will be left with very little money to lend to others like companies in the private sector. The impact of the government’s large borrowing plan is already felt as the yield on government bonds has risen to 7 per cent.

The banks will also be too happy to lend more to the government at the cost of private sector because the risk of sovereign borrowing is zero. Naturally, the government’s borrowing will crowd out private sector and push up interest rate. Corporates and large & medium entrepreneurs are already complaining about non-availability and high cost of funds for more than year now. They fear that the situation will get worse.

Shortage of fund is a bad news when the government is pushing for higher growth and enhanced economic activity. In fact, many fear that smothering funds out of the banking system will be counterproductive to growth and will be self-defeating the government’s economic revival1 plan.

DH News Service

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