After white rule ended in South Africa, President Nelson Mandela set up a Truth and Reconciliation Commission to inquire into apartheid atrocities. He did not seek a Nuremberg-style trial to hang all the guilty, which would have created an irreparable rift between whites and blacks. Rather, he wanted to reveal the truth about white atrocities, give an amnesty to the confessors in return for honesty, and make a fresh start with a clean slate.
India’s next Budget should take the same approach. We need a budget for truth, forgiveness and reconciliation. For too long the truth about the government’s spending and borrowing has been hidden by layers of financial fudging. Such fudging has been done by all political parties.
The Financial Responsibility and Budget Management (FRBM) Act requires the central government to reduce its fiscal deficit to 3% of GDP, and that has become a hallmark of financial prudence. But state and central finance ministers often find revenue falling short of expectations, and new populist schemes keep busting spending estimates. They don’t want to be seen breaking FRBM targets. So, instead of cutting unproductive spending, they resort to two fudges.
One is simply not to pay their dues, and let these payments spill over into the next year. This lessens the actual cash outgo in the current year and gives a fictitious impression of prudence. However, this means the next year starts with an inherited burden, which is then countered by even more delayed payments in subsequent years. The amount of fiscal fiction accumulates over time. Even worse, the central government last year demanded and got advance payments for the next year for rail freight from NTPC and Coal India. This artificially reduced the fiscal deficit for 2018-19 but created a corresponding problem for the next year.
India must shift from its current “cash accounting” system to what is called an “accrual system” in which due payments are listed as spending and cannot be fudged by delaying payments. That will make budgets more honest and transparent.
The second big fudge is to finance fiscal deficits not by formal budgeted borrowing but by what is called off-budget borrowing. Instead of central and state governments borrowing to fund their deficits, they force their own public sector entities to do the borrowing. The overall economic impact is the same. Yet the budget gives a false impression of fiscal prudence.
The Comptroller and Auditor General last year blew the lid on this accounting scam. For 2017-18, the formal central fiscal deficit was 3.46% of GDP. But the CAG calculated that off-budget borrowing was virtually 2% more, making a true deficit of 5.5% of GDP. Enormous sums were borrowed by the Food Corporation of India but not reimbursed by the central government. Undoubtedly a similar exercise for state governments will show that their combined deficits are maybe 3-4% of GDP, not the officially claimed 2%.
The total deficit of the Centre, states and public sector undertakings is called the Public Sector Borrowing Requirement (PSBR). Economist Sajid Chinoy has calculated that this PSBR is at least 9% of GDP. Since India’s entire household financial savings amount to only 7% of GDP, such high government borrowing pushes interest rates to levels that hurt economic growth.
For decades, financial fudging was common in corporations and banks that lent to them. Enormous defaults were cloaked by keeping on lending afresh. This game came to an end with the revelation of lakhs of crores of bad debts. The RBI finally forced banks to own up their true losses. The hole in their finances had to be patched up through fresh infusions of bank capital. This cleaning up of the financial mess is a work in progress. It will reveal the truth, write off unpayable debt, and enable fresh lending to start on a clean slate. In effect, the banking system has been forced to take Nelson Mandela’s path of truth and reconciliation.
We need the same approach for the Budget too. Here again we need to first admit the truth about cumulative fudging and clean up the mess.
Admitting the truth will mean a one-time jump in the fiscal deficit to a whopping 6-7% of GDP, almost double the official but fudged budget figure. We can return the following year to fiscal honesty and truly reduce the deficit in stages to the targeted figure.
This will be politically inconvenient. But India needs to end politically convenient fudging and take the Mandela path.