by Vivek Kaul
The government follows the cash accounting system and only acknowledges expenses once payment has been made. This has led to a situation wherein subsidy payments to the FCI and the fertilizer companies remain unpaid. The money has been spent by the FCI and the fertilizer companies towards the subsidy, but remains unpaid by the government, and hence, is not acknowledged as an expenditure.
The question is: Where does the FCI get this money from? It borrows from the financial market. Why does the market lend money to the FCI? It does that because it knows that it is effectively lending money to the Indian government. Hence, this subsidy expenditure has already been incurred by the government, but has not been accounted for.
This is not a good practice, given that the aim of any accounting process should be to put forward the correct financial picture. By postponing the payment of bills, the government beats that very purpose. It needs to be pointed out here that this isn’t something that the Narendra Modi government started. It was something that they have inherited from the previous Congress-led United Progressive Alliance government. This is something that Jaitley’s predecessor, P Chidambaram, used to do, and Jaitley has simply carried on with the practice.
Prudent accounting demands that these expenditures be accounted for during the course of the financial year. One can understand that the government may not be able to account for it in just one year, but then it always has the option of accounting for it over a period of two years. But not accounting for an expense in order to meet the fiscal deficit target is simply not correct, not to mention not good economics.
In fact, there is another trick that Indian governments over the years have resorted to in order to come up with a lower fiscal deficit figure. As the then RBI Governor, Raghuram Rajan, had said in a January 2016 speech: “The consolidated fiscal deficit of the state [governments] and Centre in India is by far the largest among countries we like to compare ourselves with; presently, only Brazil, a country in difficulty, rivals us on this measure. According to IMF estimates (which is what the global investor sees), our consolidated fiscal deficit went up from 7 per cent in 2014 to 7.2 per cent in 2015. So, we actually expanded the aggregate deficit in the last calendar year.”614
The reason why the government’s figures are different from the IMF figures is because the government of India underdeclares its fiscal deficit. How does it do it? One way, explained above, is by not accounting for expenditure that has already been incurred. Another trick that the government uses is to recognise the divestment of shares in central public sector enterprises as a revenue rather than as a financing item, as practised by the IMF.
As the economist Rajiv Malik of Credit Lyonnais Securities Asia (CLSA) puts it: “The FY 16 [financial year 2015-2016] budget deficit target—adjusted for divestment—was actually 4.4 per cent of the GDP, not 3.9 per cent, as officially reported.”615
Hence, one of the repercussions of Big Government is the underdeclaration of the fiscal deficit. Also, as we shall see, this is not the only negative effect of Big Government on the finances of the union government.
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When Narendra Modi was sworn in as the Prime Minister of India on May 26, 2014, the price of the Indian basket of crude oil was at $108.10 per barrel. By the end of September 2016, the price was around $43.50 per barrel. Interestingly, it even touched a low of $26.95 per barrel on February 12, 2016. Between May 2014 and February 2016, the oil prices saw a massive fall of 75 per cent.
In fact, oil prices fell dramatically within months of Modi taking over as Prime Minister. By mid-October 2014, the price of the Indian basket of crude oil had fallen to $83.80 per barrel. The government used this opportunity to deregulate the price of diesel. Until then, the price of diesel had been decided by the government.
Before October 2014, this led to a situation wherein the oil-marketing companies (Bharat Petroleum, Hindustan Petroleum and Indian Oil Corporation) had to sell diesel at a price which was below their cost price. The government, along with the oil production companies (Oil and Natural Gas Corporation, and Oil India Ltd.), had to compensate the oil-marketing companies for these under-recoveries.
This led to the expenditure of the government going up. A higher expenditure meant a higher fiscal deficit, and this had its own set of problems.
Trying to manage the price of a commodity is another excellent example of Big Government. As the economist Henry Hazlitt writes in Economics in One Lesson:616
We cannot hold the price of any commodity below its market level without in time bringing about two consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are tempted to buy, and can afford to buy, more of it…. In addition to this, production of that commodity is discouraged. Profit margins are reduced or wiped out. The marginal producers are driven out of business.
The demand for diesel went up in the form of people buying more and more passenger cars that ran on diesel, given the substantial difference between the price of petrol and diesel. (Remember that petrol prices were already deregulated, but diesel prices were deregulated only in October 2014.) Hence, before October 2014, the government of India was indirectly subsidising diesel car owners. This meant that rich consumers ended up consuming more than their fair share of diesel.
As Hazlitt writes in this context: “Unless a subsidised commodity is completely rationed, it is those with the most purchasing power that can buy most of it. This means that they are being subsidised more than those with less purchasing power…. What is forgotten is that subsidies are paid for by someone, and that no method has been discovered by which the community gets something for nothing.”617
As the government subsidised diesel car owners and incentivised car companies towards selling more and more diesel cars, its expenditure went up. And this expenditure largely benefited the rich carowning class. Of course, the money that went towards subsidising diesel and diesel cars could easily have gone towards education, health, the environment, and so on. But that is not how things eventually turned out.
The regulation of diesel prices also drove private marketers of oil (Reliance, Essar, etc.) out of business, as suggested by what Hazlitt had to say on the issue. Until October 2014, the government-owned oil-marketing companies were compensated by the government and the upstream oil companies for selling diesel at a lower price. There was no such compensation for the private oil marketers, and hence, they had to shut down their business.
Furthermore, the upstream oil companies, which actually produced oil, had lesser amount of money available to prospect new oil fields. It is worth being reminded here that India imports nearly four-fifths of its oil needs. If this dependence on foreign oil has to come down, the Indian oil production companies need to produce more oil. This can only happen if they start exploration for more oil fields. And exploring oil fields is a costly affair that requires a lot of money.
As mentioned earlier, since, by October 2014, the price of oil had fallen to $83.80 per barrel from $108.10 per barrel in May 2014, the government used this opportunity to deregulate the price of diesel. As Finance Minister Jaitley, who often acts as spokesperson for the Modi government, said after the decision was made by the Union Cabinet: “Henceforth—like petrol—the price of diesel will be linked to the market…. Whatever the cost involved, that is what consumer will have to pay.”
The proposal to allow oil-marketing companies to decide the price of diesel was first made in 1997, when Inder Kumar Gujral was the Prime Minister. The price of petrol and diesel were finally deregulated in April 2002, under the regime of Atal Bihari Vajpayee.
But this decision was overturned in late 2004, around the time oil prices had touched $50 per barrel. In November 2004, Mani Shankar Aiyar, the then Petroleum Minister, had said: “Since January 1, 2004, the government [the previous NDA government]… [had been] dictating even petrol and diesel prices.” He went on to claim that the UPA government had “been far more honest in saying” that it would “control [the]
prices of cooking and auto fuels”.618
And this is how things stood till October 2014, when diesel was finally deregulated again. This had become necessary, given that, in the previous two financial years (i.e., 2012-2013 and 2013-2014), the total petroleum subsidies had amounted to around Rs. 1,82,360 crore. In fact, it was estimated that around half of this was due to the under-recoveries on diesel. The remainder was due to under-recoveries on cooking gas and kerosene.
Furthermore, it was estimated that, for every one dollar increase in the price of oil globally, India’s petroleum subsidy bill went up by a billion dollars.619 This deregulation of diesel prices, along with the fall in oil prices, helped the government bring down the petroleum subsidy. The point is that, if this hadn’t happened, the finances of the Modi government would have gone for a toss totally. The petroleum subsidy figure fell from Rs. 92,000 crore in 2013-2014 to a little over Rs. 60,000 crore in 2014-2015, to around Rs. 30,000 crore in 2015-2016. For 2016-2017, around Rs. 27,000 crore has been budgeted for the petroleum subsidy.
The government benefited on two counts. First, it got a lower petroleum subsidy bill. Secondly, it captured a large part of this fall in oil prices by increasing the excise duty on petrol and diesel. Between November 2014 and early 2016, the excise duty on oil and petrol was increased nine times.
The total excise duty collected by the government on petrol and diesel in 2014-2015 had stood at around Rs. 1,56,000 crore. This jumped by 59 per cent to a little over Rs. 2,48,200 crore in 2015-2016. Hence, lower oil prices were a huge benefit to the government. The state governments also cashed in by increasing the value-added tax on petrol and diesel.
A press release put out by the Bhartiya Janata Party in February 2016 said that all state governments, except Mizoram, Assam, Tamil Nadu, Chhattisgarh and Gujarat, had increased the value-added tax on petrol and diesel. So both the union government and the state governments, in a way, worked together to ensure that the end consumer did not get the total benefit of lower oil prices.
By increasing the excise duty on petrol and diesel, and not passing on the benefit of lower oil prices to the end consumer (in the form of lower petrol and diesel prices), the government was essentially trying to increase its revenues. This is another way through which the government tries to make up for all the Big Government expenses that it needs to finance during the course of the year. Of course, this was not just to finance the Big Government expenses.
As mentioned earlier, the total revenue that the government has been earning as a proportion of the GDP has also fallen over the years. In 2007-2008, the tax-to-GDP ratio was at 11.9 per cent. By 2015-2016, this had fallen to 10.6 per cent. This means that the government lost out on taxes worth Rs. 1,76,000 crore in 2015-2016.620
In such a scenario, it is not surprising that the government is looking at other ways to raise its revenues. But this comes with its own share of costs. Soumya Kanti Ghosh, the Chief Economic Adviser of the State Bank of India, made an interesting calculation on this. In a research note titled ‘If Wishes Were Horses’, Ghosh tried to calculate the total savings that end consumers would have made if the government had not increased the excise duty on petrol and diesel and passed on the entire benefit of the fall in the price of oil.621
Ghosh comes to the conclusion that this “would have translated into Rs. 90,000 crore of savings for the consumers”. Of course, consumers would have spent this money, and this could have provided an additional demand to the economy to the extent of 1 per cent of the GDP.622 And that would have been a huge thing. As is well known, the multiplier effect of consumer spending is significantly better than that of government spending, where leakages are huge.
Of course, if the government had done things along these lines, it would have meant that the fiscal deficit of the government would have gone up. If the government had given up taxes to the tune of Rs. 90,000 crore (actually less than this, but I will come to that), its earnings would have fallen, leading to an increase in its fiscal deficit.
Actually, the increase in fiscal deficit would have been lower than Rs. 90,000 crore. This is because the increase in consumer demand, had the excise duty on petrol and diesel not been raised, would have also brought in some money to the government in the form of both direct and indirect taxes. Of course, it remains difficult to quantify this.
Furthermore, there were other ways through which the government could have looked at bringing down its fiscal deficit. For starters, it owned 11.2 per cent stake in the cigarette maker ITC through the Specified Undertaking of the Unit Trust of India. This stake, as on March 31, 2016, was worth close to Rs. 19,610 crore. Why does the government, which runs anti-tobacco advertisements, continue to own a cigarette manufacturing company?
This stake could have been sold, and a significant portion of the increase in the fiscal deficit could have been covered. Those who like to support the Modi government on all issues like to point out that the ownership of ITC shares brings in a dividend for the government. Hence, why let go of this regular income?
The question to ask here is: What is the dividend yield of ITC? Well, it’s only 1.7 per cent. Dividend yield is the total dividend the company has paid out during the year divided by its current market price. The dividend yield of ITC is less than half of the return of 4 per cent available on a savings bank account. Given this, the dividend yield argument clearly does not work.
Over and above this, the Life Insurance Corporation (LIC) of India owns a 14.4 per cent stake in the company. Effectively, the government owns one-fourth of ITC. Hence, this stake could easily be strategically sold at a price which is better than the prevailing market price.
Also, the government continues to run many loss-incurring companies. This costs the government more than Rs. 20,000 crore every year. The government keeps bearing these losses. If many of these loss-incurring companies are shut down and their assets (primarily land) gradually monetised, it would tremendously benefit the government. The government has started to make some noise along these lines, as we shall see in the conclusion to this book.
Jaitley said in his February 2016 budget speech: “A new policy for [the] management of Government investment in Public Sector Enterprises, including disinvestment and strategic sale, has been approved. We have to leverage the assets of Central Public Sector Enterprises (CPSEs) for [the] generation of resources for investment in new projects. We will encourage CPSEs to divest individual assets like land, manufacturing units, etc. to release their asset value for making investment[s] in new projects.” Let’s hope that this doesn’t end up as just another paragraph in a finance minister’s speech.
The disinvestment target at the beginning of 2015-2016 was set at Rs. 69,500 crore. Only Rs. 25,313 crore was achieved. Hence, if the government had made an effort to earn money through these routes, it wouldn’t have had to increase the excise duty on petrol and diesel nine times since November 2014. But that would have called for the cutting down on Big Government, which, at the risk of sounding very clichéd, is easier said than done.
11. IT’S NOT THE INTEREST RATE, STUPID!
If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has.
– JOHN MAYNARD KEYNES
Big Government in India is nowhere more obvious than when it comes to banking. The government-owned Public Sector Banks (PSBs) had given out close to 71 per cent of the loans of the Indian banking system (see Table 11.1) as on March 31, 2016. The loans that a bank gives out are essentially an asset for it.
The government is the major owner of the PSBs, though it does not own them completely, given that many of these banks are listed on the stock market.
Table 11.1: Total loans of banks as on March 31, 2016.
Total Advances/Loans
(in Rs. crore) Total Net Profit in 2015-2016 (in Rs. crore)
Private Sector Banks 19,39,339 41,314
Public Sector Banks 55,93,577 −17,992
Foreign Banks 3,63,388 10,828
Total 78,96,304 88,562
Proportion of loans given out by Public Sector Banks 70.8%
Source: Indian Banks’ Association.
The government owning banks is not something out of the ordinary. It is par for the course in countries that Wall Street likes to refer to as the emerging markets, or what used to be the Third World till a few decades ago.
In fact, on an average, the government-owned banks control 32 per cent of all banking assets in the twenty largest emerging markets. The figure is more than 40 per cent in Brazil, China (where the distinction between the government and the private sector is not always clear and the actual number is likely to be much higher), Indonesia and Thailand. Furthermore, it is 50 per cent or more in Hungary, Malaysia, Russia and Taiwan.623 In India, the figure is close to 75 per cent, i.e., the government owns close to three-fourths of the banking assets in the country.
And this manifestation of Big Government comes with costs attached to it. Take a look at Table 11.1. Even though PSBs control close to three-fourths of India’s banking assets, and 71 per cent of the loans, their total net profit in 2014-2015 stood at Rs. 37,540 crore. This turned into losses of close to Rs. 18,000 crore in 2015-2016. In comparison, the private sector banks made a profit of Rs. 41,314 crore during the course of the year, despite giving out only around one-fourth of the total loans of the Indian banking system.
As Ruchir Sharma writes in The Rise and Fall of Nations: “Spend a lot of time in the field and it is all too easy to find evidence that the state is not a competent banker.”624 The situation is not very different in India on the banking front. That the state is not a competent banker has become clear over the past few years. Even though the PSBs have not been in good shape for more than a few years now, it all came into the public consciousness when Vijay Mallya left for the United Kingdom in early March 2016.