The Union government has set a disinvestment target of Rs 1.75 lakh crore in the Budget for the financial year 2021-22. This target is not only set for this year, it was set to be Rs 2.1 lakh crore for 2020-21 as well. However, the estimated disinvestment stood at Rs 32,000 crore in 2020-21 because of the lockdown. In 2019-20, the actual disinvestment was more than Rs 50,000 crore (Budget at a Glance).
There are protests throughout the country against this sale of public assets. However, the government seems to be desperate when the fiscal deficit has increased to 9.5% of the GDP in 2020-21 (revised estimate). (See graph 1)
But the government could also explore the route of financing part of the fiscal deficit by borrowing from the Reserve Bank of India (RBI). The foreign exchange reserve of the RBI stood at $582 billion or more than Rs 42 lakh crore as on March 19, 2021. This is equivalent to almost 22% of the GDP. This huge idle asset has been piled up for managing the exchange rate. Therefore, the RBI is absolutely in a comfortable position to lend some money to the government to finance part of its fiscal deficit.
The government may explore this possibility of monetising (ie, borrowing from the RBI) part of the fiscal deficit instead of desperately going for disinvestment of the valuable and strategically important public sector assets. Mere changing of ownership of these assets would not help increase the aggregate investment (public plus private investment) in the economy. Disinvestment per se does not help in boosting the aggregate level of employment and output —it may only help in reducing the fiscal deficit, given the present accounting norm.
Deciphering Fiscal Deficit
Fiscal deficit is the gap between expenditure and revenue of the government. Aggregate government expenditure has two major components — revenue expenditure and capital expenditure. The current expenditures of the government like salary of government employees, pensions, interest payment on the accumulated government debt, running costs of various schemes, etc, are categorised as revenue expenditures. Expenditures spent on building capital assets are called capital expenditure.
According to the present accounting norms, if there is a transfer of funds from higher to lower tier of government, ie, from Union government to State governments or from State governments to local bodies (panchayats, municipalities and city corporations), these come under revenue expenditure. However, part of this spending may actually be incurred to build capital assets like school buildings, hospitals, roads and bridges, etc. Accordingly, the effective capital expenditures and revenue expenditures are calculated.
On the revenue side of the government exchequer, there are tax and non-tax revenues. Again, the tax revenues can be categorised as direct taxes like income tax, wealth tax, profit tax, and indirect taxes like Goods and Services Tax, sales tax and excise duties. The non-tax revenues comprise various royalties, dividends of the public sector units (PSUs), etc. Tax and non-tax revenue together constitute the total revenue receipts of the government.
Fiscal deficit is calculated as revenue expenditure plus capital expenditure minus revenue receipts. Capital receipts are not deducted from the government expenditures to calculate fiscal deficit. Capital receipts are mainly borrowings of the government to finance fiscal deficit. If we incorporate capital receipts, fiscal deficit or surplus would be zero – the expenditure and receipt side of the budget must always match (after adjusting for cash-balances of the previous period and the net loan component).
Managing Fiscal Deficits
- Disinvestment Proceeds
Interestingly, the disinvestment proceeds are included in the capital receipts of the government as non-debt capital receipts (NDCR). But, along with the revenue receipts, NDCR is deducted from the government expenditures to calculate the fiscal deficit. This exception is made in the present accounting norm because NDCRs are non-debt creating capital receipts. If the government borrows from the central bank or commercial banks or from abroad to finance the fiscal deficit, it becomes indebted to them. However, if the government sells the existing PSUs like Air India or public sector banks or insurance companies, or electricity generating companies, etc, it does not become indebted to anybody to finance its deficit.
In a real sense, there is hardly any difference between decumulating the public sector assets (that have been accumulated over the years using the tax payers’ money of the previous generations at one go) and accumulating debt to finance the deficit. Many economists argue that it is wrong to treat disinvestment proceeds as analogous to revenue receipts and that is why it is considered to be capital receipt.
Disinvestment may not involve future interest payments, but it does affect future revenue streams for the government since its share of dividends would go down forever in the future. Financing fiscal deficit by disinvestment instead of borrowing is like selling the accumulated stock of wealth for meeting the current expenditure need of the government – conceptually, it is just like opposite of the government investment.
- Injecting Extra Demand
The world economy is suffering from acute demand problem, more so after the Covid-induced lockdown. Many have lost their income and purchasing power and as a result, there is less demand for goods and services. This, in turn, is reducing the profitability, employment, wage rates and income. That would reduce the aggregate demand further. To get rid of this vicious cycle, it is important that the government injects extra demand into the economy through incurring larger fiscal deficit.
When the government incurs some expenditure, some economic agent earns extra income and when the government taxes, peoples’ disposable income reduces. Therefore, when the government spends more than the tax revenue (ie, incurs deficit), the purchasing power of people increases. Part of that increased income would be spent as consumption expenditure on domestically produced goods and services which, in turn, would be earned by some others and so on and so forth. This way, the aggregate demand would increase by more than the initial increase in government spending. This is called the Keynes-Kahn multiplier process in the literature of economics.
The value of deficit-financed government expenditure multiplier is always higher than the tax-financed multiplier in the sense that certain amount of government expenditure would be more effective in increasing the level of output and employment if it is financed by borrowing instead of taxation. Tax is a leakage of multiplier. So, the Keynesian demand-management policy of deficit financing is the general policy prescription under the demand depression.
There is lack of aggregate demand particularly after the Covid-induced lockdowns. Under this situation, the revenue shortfall would be high but, the government expenditures cannot be reduced rather it should be increased for faster recovery. As a result, the fiscal deficit is bound to go up. The current combined fiscal deficit of the Centre and the State governments would be more than 13% of the GDP in India. But this is not the time for fiscal conservatism.
Larger fiscal deficit to the GDP ratio does not cause ‘crowding-out’ of private investment by increasing the real rate of interest under a demand-constrained situation. Private investment is not increasing as a proportion to the GDP because of the lower expected profit rate in the market. Business confidence is lower because of lack of demand and lack of purchasing power of people. If the expansionary demand management policy of the government can revive the aggregate demand, business confidence would revive and there would be ‘crowding-in’ of private investment.
- Inflation Factors
Even if the fiscal deficit is financed through borrowing from the RBI (monetised), it would not cause demand-pull inflation. Inflation is happening even under the acute demand problem not because of the demand exceeding supply but, maybe because of the increase in petroleum prices. This is not demand-pull inflation — this is cost-push inflation. Under a situation when lack of aggregate demand is the problem, injecting demand through larger monetised fiscal deficit does not cause extra inflation. The interest payment component may go up in the government exchequer because of larger borrowing. Here, the RBI may always choose to lend to the government at a discounted rate. Anyway, the rate of return on its foreign exchange reserve is negligible. If the part of fiscal deficit is monetised, it would not put any pressure on the interest rate also. Movements in interest rate are primarily policy determined.
- Domestic Borrowing
The fiscal deficit also can be financed by borrowing from the domestic market — from the commercial banks, etc. If the commercial banks are willing to invest more in government securities, there is no harm in it. However, it would depend on their credit-deposit ratios and demand for credit in the market. This, in turn, would depend on the expected rate of profit. The credit-deposit ratio of all the commercial banks taken together was more than 76% before the lockdown. This came down steadily after the lockdown to 72% by the end of September last year. It is still around 72% as on 12th March this year and not showing any sign of recovery yet.
The commercial banks’ investment in government and other approved securities as proportion of their net demand and time liabilities (deposits) has increased from 27% in end-March to more than 31% in end-September last year. It is still more than 30% as compared to statutory liquidity ratio (SLR) of just 18%. Although, the rate of return on the government securities is much less than the lending rates yet, this is happening because of lack of demand for credit in the market. Apart from the proportion of fiscal deficit that the commercial banks and others are willing to finance, the rest of it can be financed through monetisation or borrowing from the RBI.
- Using Forex Reserve
The foreign exchange reserve of the RBI was Rs 35.5 lakh crore ($475.5 billion) on 27th March 2020. This increased by Rs 6.7 lakh crore or by around 3.5% of the GDP during April 2020 to March 2021. (see graph 2). There is absolutely no harm in using this money for financing part of the fiscal deficit. In fact, the RBI can lend more also under this exceptional situation of huge demand depression to give the economy a big-push for faster recovery.
The disinvestment of PSUs, as mentioned above, would not help anyway in reviving the economy. International rating agencies’ rating would not come down only because of the higher fiscal deficit to the GDP ratio but, also because of lower growth, higher unemployment, etc. Therefore, instead of showing desperation for selling off the public sector assets, the government should undertake expansionary fiscal policy, partially financed by monetisation, for reviving the aggregate demand, growth, level of income and employment, profitability and business confidence sooner than later. If growth revives, the revenue receipts of the government would automatically improve and, as a result, the fiscal deficit as a proportion to the GDP would also come down in the near future.
(The author is Assistant Professor, Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi)
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