RBI needs to calculate and monitor public sector borrowing requirement
After the interim budget, economic experts on TV bemoaned the smoke and mirrors that cloak the true extent of the fiscal deficit. The Comptroller and Auditor General (CAG) recently castigated the government for using off-budget borrowing on a massive scale thorough public sector agencies to avoid showing such borrowing in its own books. Instead of just moaning about this every year after the budget, we need a way out.
One way out stares us in the face. This is to calculate the public sector borrowing requirement (PSBR), defined as borrowing by not just central and state governments but also by all public sector corporations and agencies. This consolidated figure will more or less put an end to tricks in shifting debt from one arm of the government to another to manipulate the fiscal deficit.
The Dues are Due
CAG highlighted the way massive dues to the Food Corporation of India (FCI) kept going up year after year, as well as dues to the National Bank for Agriculture and Rural Development (Nabard) and the fertiliser subsidy account. FCI alone borrowed 1.3% of GDP from nonbudget resources in FY18 and another 1% of GDP in FY19.
CAG calculated that financial jugglery had been used to understate the total central public account liability by ₹7.63 lakh crore, or a whopping 5% of GDP, by the end of 2016-17. This meant the true level of central debt was not 45.5% of GDP as officially stated but 50.5%. That, in turn, means the task of meeting the new Fiscal Responsibility and Budget Management (FRBM) target, of reducing central debt-GDP to 40% by 2025, is literally twice as onerous as it appears at first sight.
The Reserve Bank of India (RBI) should have taken the lead in calculating and highlighting trends in the PSBR ages ago. After all, RBI is concerned with monetary policy, with the factors affecting interest rates and bank funds available for investment and other purposes. For RBI, it is crucially important to know the consolidated figure for the loan demand of not just the central and state governments, but also their corporations and agencies, who also borrow absolutely massive sums. It needs to share detailed information on trends in the PSBR with the public, helping identify which areas cry out for correction.
After every budget, some experts always declare that the fiscal deficit is too much and will crowd out private sector borrowing. Truth is, crowding out is determined by the full PSBR, not just the budget borrowing. Hence, the PSBR should be a critical parameter highlighted in budget documents and RBI reports. It should be debated before RBI decides whether to raise or lower interest rates, and whether to loosen or tighten monetary policy.
In the absence of official figures, Sajjid Chinoy of JPMorgan recently attempted to calculate the PSBR of the Centre and states. He came up with a high figure of 8.5% of GDP. Moreover, this did not include off-budget loans of state governments and their agencies. If these are included, the full PSBR may exceed 9% of GDP. This is almost frighteningly high by international standards. It is surely one reason why real interest rates in India are too high, hitting the competitiveness of Indian industry.
Chinoy notes that some borrowing, as well as off-budget borrowing, finances much-needed infrastructure and other capital expenditure. Nevertheless, this constitutes a claim on domestic household savings, which have fallen from 23% of GDP to 17% in recent times, with net household financial savings falling to just 7% of GDP.
Government borrowing for productive investment is entirely justified, and if well-implemented — and that’s a very big if — it can crowd in, rather than crowd out, private investment. Alas, too much borrowing is still used to finance freebies, loan waivers, non-merit subsidies, and wasteful and pointless schemes.
Borrowing for such purposes is unsustainable and puts upward pressure on interest rates and available credit. Chief ministers seem to believe, going by the explosive proliferation of budget provisions for cow welfare and gaushalas, that this is necessary for political reasons. But this is exactly the sort of activity that must not be financed by borrowing.
Let me not exaggerate the extent of the problem. Many other countries also use off-budget accounting tricks. India’s macroeconomic fundamentals are pretty good. But if one disregards the recent unsustainable collapse in agricultural prices, the country’s inflation and interest rates have long been uncomfortably high by emerging market standards.
India’s government debt-GDP ratio was 84% of GDP back in 2003. Then it declined to 65%, and is now around 70%. This is modest compared with ratios of 250% in Japan, 130% in Italy or 105% in the US. However, the rate of interest on gilts in those countries is not far above zero, whereas Indian gilts bear around 7.5% interest. One-third of all central revenue disappears in interest payments.
This is sustainable as long as GDP growth remains rapid. Yet, India needs to learn from much lower debt-GDP ratios in developing countries like China (47%), South Korea (38%) and Indonesia (28%). The lower that ratio, the lower will be interest rates and export competitiveness.