A V Rajwade: Cover the full ground

Adherence to a fiscal deficit target without full reform of govt accounts may not be sufficient

Most commentators on the Budget have complimented the finance minister on restricting the fiscal deficit to 3.2 per cent of gross domestic product (GDP). The debt raised to finance the deficit increases the debt to (nominal) GDP ratio, if the increase in debt is more than the increase in nominal GDP, projected at 11 per cent for 2017-18.
 
The Economic Survey released just before the Budget compared the government debt to GDP ratio of 17 large economies. To my surprise, our ratio at 68.5 per cent (2016), is very close to Germany’s 68.2 per cent (Japan’s ratio is the highest at 250 per cent, followed by Italy and the US) — and Germany has been a fiscal “hawk” within the euro zone, vetoing any member country’s desire to relax the deficit limits. It is also the fastest growing economy within the zone, as is India among the Group of Twenty large economies. The other side is that Argentina (51.8 per cent), South Africa (51.7 per cent) and Turkey (31.7 per cent), countries with much lower ratios, are facing slow growth and financial instability. (While the numbers quoted are for 2016, data 2007 onwards are not materially different.)
 
This pattern is also repeated in the primary balance (that is, the surplus/deficit between government receipts and non-interest expenditure). Among the major emerging economies, over the last 10 years, India has by far the highest average primary deficit as percentage of GDP (3.2 per cent), and the second-highest GDP growth (7.4 per cent), next only to China’s 8.9 per cent. The two economies with the largest primary surplus are Brazil (1.2 per cent) and Turkey (1.1 per cent) — with average real GDP growth rates of two per cent and 3.5 per cent. Is fiscal prudence, reflected in the ratios, an overrated virtue, if long-term growth is the objective of macroeconomic policy? 
 
One wonders whether these apparent anomalies are the result of the numbers reflecting only the quantity, not the quality, of the fiscal balance. For example, deficits arising from investments, say, in tangible assets like infrastructure, have an entirely different impact on future GDP growth than deficits arising from, say, an increase in salaries of government employees. Arguably, so does “investment” in intangible assets like education and health care. Today’s fiscal accounting clubs dub everything as “expenditure”. And as for stock, we have no idea of the market value of assets created with the debt. There is a clear need to move to a “true and fair”, or accrual-based, accounting of the central government finances on both the flow and the stock bases. The International Public Sector Accounting Standards Board (the expression “public sector” has been used in the sense of “government”) has come out with a standard for government accounts. To quote from a note on the subject published by the International Federation of Accountants:
 

• “A key issue for public sector financial reporting is that many governments still adhere to the cash basis of accounting… There is a growing demand for the same level of financial transparency and accountability from the public sector as is expected from the private sector.”

• “Government debt alone does not provide a comprehensive picture of fiscal soundness. The full disclosure of all assets, liabilities and contingent liabilities is vital for assessing the true economic implications of public sector financial management.” 

Take one issue: In the case of our Budget is the present value of the government’s pension obligations considered and provided? Surely, it is a liability, and needs to be financed or, at least, included as government debt? Again, I have seen comments suggesting that the inflow from small savings has been overestimated and that actual market borrowings may have to be more than budgeted. Does it imply that small savings are treated as revenue, not borrowing?
 
On the other hand, capital investments and investment in public sector enterprises surely create assets for the economy. Do we have any idea of the market value of such assets — or, indeed liabilities of public sector enterprises, which have an implicit government guarantee? One example: Can you imagine the National Highways Authority of India defaulting on a bond obligation?
 
On a national scale, investment in the economy as a percentage of GDP has been falling in recent years. We clearly need to increase it if growth is to be sustained and jobs created for the 12 million estimated to be entering the job market each year. And, a mechanical adherence to a fiscal deficit or the primary balance target without a full reform of government accounts on both flow and stock bases may not be sufficient. It will be interesting to see what the panel reviewing the FRBM Act comes out with.

The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com