Past experience indicates that if there has to be a compromise made, it should be at the expense of capex
A universal chant appears to be that the government will play a critical role in rejuvenating the economy this year.
With private sector investment not taking off at the desired pace, it is logically concluded that the government is best placed to kick-start the investment process by spending more. After all, the government is the only entity that can borrow at the lowest possible cost, which is today around 7.8-8%, depending on the tenure. The logic goes that, once the government spends, there is a virtuous backward linkage with the rest of the economy as demand is created for, say, cement, iron, steel, machinery and so on. This will lead to better capacity utilisation in the private sector, leading to higher investment to keep pace with demand.
The story line is obviously neat and cannot be contested. But there are two thoughts that need to be considered. The first is the government is constrained in a way by FRBM norms, and when we stick to a fiscal deficit ratio of 3.9% of GDP, there is generally speaking no compromise on this number. Thus, to have a Keynesian expansion of a larger order is ruled out and whatever can be done has to be within the confines of budgetary numbers. The second is a logical extension of the first—what kind of numbers are we talking of?
The size of the Indian economy is around R125 lakh crore at current market prices. What kind of push is really required from the point of view of the central government to influence this number? Here there are two aspects. The first is the absolute number of capital expenditure that is being incurred by the government and the second is the compulsions imposed by the government in enabling such expenditure. The accompanying table provides data on total expenditure, plan and non-plan capital expenditure in the last five years.
What stands out from the table is that the share of capital expenditure in total budget expenditure is just between 11-13% and works out to around 1.5% of overall GDP at current market prices. This amount is quite small to have a significant impact on the overall level of capital formation. Second, this amount has been increasing in numerical terms from R1.59 lakh crore in FY12 to R1.92 lakh crore in FY15. Third, the share of plan capex is now slightly higher than that of non-plan capex. The chief component of non-plan capex is defence which adds to capital formation by expense on equipment. However, a large part could be through imports, in which case it would not add to productive capacity within the country. Almost 90% of non-plan expenditure of the government is on defence, which hence has less impact on backward linkages. Fourth, plan capex has finally tended to be lower than budgeted, which means that it is compromised in case there are fiscal challenges towards the end of the year. The shortfall has been in the range of 11-17% in the last three years, when there were fiscal pressures too. Finally, in the last three years, the overall size of the budget was lower as per revised or actual estimates relative to what was budgeted. The lower level of expenditure of between 5-6% was mainly on account of revenue not increasing as the economy had not shown the buoyancy required to meet the targets.
Another feature which does not come out from the table is that, overall, the non-plan expenditure of the government has gone along with what was budgeted as most of the components like subsidies, interest payment and defence cannot really be lowered, being virtually committed expenditures. As a corollary, the government has actually cut down on plan expenditure and the extent has been almost identical to the difference between the budgeted and actual/revised size of the budget. In FY14 and FY15, the drop in plan expenditure accounted for 95% of the overall reduction in expenditure, while in FY13 it was 135% with non-plan expenditure overshooting.
The takeaways are, one, that any reduction in expenditure which has to be invoked by the government has to be from plan expenditure—the discretionary part of the budget. With 75% being non-plan expenditure, the focus of adjustment falls directly on plan expenditure. Here the choice is between capital and revenue, and while several economic and social schemes tend to be cut back, the capex has the advantage of being lumpy and easier to administer. In FY15, for instance, the cutback in plan capex accounted for around 20% of overall cut in plan expenditure.
Two, while capex under plan expenditure has been assumed to increase by Rs 34,000 crore in FY16 over FY15, it would be significant from the point of view of the budget as it accounts for almost 35% of the increase in overall budgetary expenditure. But this amount is still quite small relative to the size of the economy. Even in terms of incremental GDP to be witnessed in FY16 of Rs 14.55 lakh crore as per the budget document, this incremental expenditure would be just 2.3%, which is not very high.
Therefore, we need to be guarded in terms of our expectations of what can be done by the central government from within its budgetary allocations and constraints imposed by pursuing the path of FRBM. Past experience does indicate that if there has to be a compromise made, it could be at the expense of capex. Even if the target is met, the number may not be too large in itself to change the state of the economy in a discernible way. The private sector has to take the initiative and we cannot expect maximum effect from the limited push in the budget, and must be abstemious in our expectations.
The author is chief economist, CARE Ratings. Views are personal