What do you think of a person who borrows Rs 45 in order to pay a bill of Rs 100, one must be seriously worried about the state of his finances. That is the predicament of the Government of India. With a projected borrowing of Rs 4,51,000 crore and a fiscal deficit equivalent to 6.8 per cent of the gross domestic product the fiscal deficit level is unsustainable.

The last financial year saw an increase in total bank deposits of about Rs 650,000 crore. If the government were to take Rs 400,000 crore (or 60 per cent of such a figure) this year very little islet for loans for productive purposes. Budget is equal to only 17 per cent of the GDP figure. Revenue deficits, unlike fiscal deficits, only add to the interest and repayment burden without creating any assets and are therefore far more worrisome. Including State Government deficits and off-balance-sheet items such as oil and fertiliser bonds, the deficit is estimated to reach about 12 per cent of GDP in fiscal 2009-10. This is what underlies the official explanation that only half the Rs 400,000 crore of market borrowings proposed by the government will be through issues in the primary market. The rest, it is said, will be done through options like the Reserve Bank’s open market operations, which invariably lead to monetization of the deficit and result giving impetus to inflationary spiral of too much money chasing too few goods. Printing money stokes inflationary pressures.

There is nothing wrong with the government running a deficit per se. The ill effects of high deficits are linked to the way they are financed and the uses they are put to. The same level of deficit can have different implications, depending upon how it is used. For instance, a fiscal deficit used for creating infrastructure and human capital will have a different impact than if it is used for financing ill-targeted subsidies and wasteful recurrent expenditure. The sustainability of the deficit will be suspect in the latter case as the use it is being put to doesn’t augment the ability to pay back the debt. The implications of deficits are, therefore, contextual.

Government spending was the fastest-growing component of GDP in 2008-09 and did indeed cushion growth from falling further. If the Centre’s high fiscal deficit could be corrected promptly, the “calculated risk” of the very high deficit for 2009/10 might be justifiable. Unfortunately, recent history does not support much optimism on this count. One’s doubts are greatly amplified when one digs a little deeper into the fiscal trends of the last two years.

The table above shows that in the two years since 2007/8, the Centre’s revenue deficit has more than quintupled in absolute terms and increased 4.5 times as a ratio to GDP. This has happened essentially because revenue expenditures have increased more than Rs 300,000 crore, while tax revenues have risen only Rs 35,000 crore. The rise in the fiscal deficit essentially mirrors the increase in the revenue deficit. The bulk of the massive expenditure increase is due to interest payments, defence, subsidies, salaries and pensions, and major social programmes such as NREGA and Bharat Nirman. The notion of a temporary fiscal stimulus assumes that it can be readily reversed when the need for the stimulus goes. None of the expenditure categories mentioned above looks very reversible. Indeed, the significance of non-compressible “entitlement schemes” such as NREGA, social security for unorganised workers and the promised National Food Security Act is on the increase in the Union Budget.

The poor recent performance of tax revenues (despite near 7 per cent growth) and the explosive increase in expenditures both suggest that rapid future correction of the currently high fiscal deficit is likely to be impossible. The Indian economy is likely to pay a significant price in terms of foregone growth, inclusive development and, perhaps, rekindled inflation because of continuing high deficits.

Whether it is really so depends on which side of the 21st century one takes into account in judging the Government’s fiscal behaviour. If one were to look at the record of the Indian economy prior to 2001 for decades, policymakers poured public money down the drain, all the while printing more money to finance non-Plan and Plan spending that left the economy flailing and panting, and yet making no progress. Then the five years of high growth showed how Governments, both at the Centre and in the States, long used to spending taxpayer money uselessly, could act fiscally responsibly. As a result of both the NDA and the first UPA Governments, the deficit narrowed to around 2 per cent on the back of growing direct tax revenues and falling public investments. Judging by the last five years therefore, the problem is not the fiscal deficit per se but the gamble it represents; if policymakers can ensure that their borrowed funds result in new investments, new jobs and new purchasing power and accelerated investments in an expanding cycle, their current ‘profligacy’ would have been worth the short-term risk. Gross market borrowings during 2009-10, at Rs 4,51,093 crore, will be 47 per cent higher than the Rs 3,06,000 crore for the previous fiscal and 2.7 times the Rs 1,68,101 crore level of 2007-08.

‘Borrow-and-spend’ policies, whether by governments or even firms and households, have obvious risks attached to them. Borrowings, after all, entail interest charges. If the mismatch between spending and earnings grows over time to necessitate ever larger borrowings, a time will come when interest itself becomes a sizable expense — not just pre-empting an increasing share of whatever little revenues, but also crowding out other (more useful) expenditures.

 The crisis today is truly not one of increased government borrowing, but of a growth slowdown. Borrowings by themselves are not a problem so long as there is the underlying GDP growth and revenue buoyancy to service them. The ultimate test is not going to be whether it will end up further bloating the Centre’s balance sheet, but whether it would help revive a sagging economy. The alternative, of course, is not to borrow and leave recovery entirely to chance, even if it entails a further hit to revenue collections

Tail piece : Personal income-tax relief measures of the Budget. Raising the exemption limit by Rs 10,000 (instead of raising the income-tax slabs) will benefit tax payers only marginally by around Rs 1,000 whereas abolishing the surcharge would benefit affluent taxpayers earning say Rs 12 lakh by some Rs 25, 000. This is not pro-poor by any means! The wealth tax threshold has also been raised from Rs 15 lakh to Rs 30 lakh.