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The Govt's Fiscal Deficit is Much More Creative Than Just Creative Accounting

Jan 29, 2019

Vivek Kaul

The finance minister Piyush Goyal will present the interim budget on this Friday (February 1, 2019). In a run up to the interim budget, there have been a spate of pieces in the media around how the revenue projections of the Modi government have gone all wrong and given that they will have to resort to creative accounting of some sort to meet the fiscal deficit target, set at the beginning of the financial year.

Fiscal deficit is the difference between what a government earns and what it spends. It is expressed as a proportion of the country's gross domestic product (GDP).

Having said that, creative accounting is something that has been an integral part of Indian budgets, over the years. The Modi government will not be the first government to resort to it.

In this piece, I don't want to talk about that. I have done enough of that by now. What I want to talk about are a few other things which help the government to meet the fiscal deficit target that it sets for itself at the beginning of a financial year. And these are a little more than just creative accounting.

Take the case of disinvestment. The government of India categorises disinvestment proceeds as a revenue item. This isn't correct, when it comes to fiscal transparency, as per the best practices of the International Monetary Fund (IMF).

In the budget for this financial year, the disinvestment proceeds, or what the government earns from selling its stakes in public sector enterprises, are expected to bring in Rs 80,000 crore. Given the way it has gone about things up until now, the government is likely to fall short of this target. But even if the government ends up earning Rs 60,000 crore from disinvestment, it will be overstating its fiscal deficit to that extent, as per the IMF best practices. This is because asset sales of any kind shouldn't be considered as a revenue item, as per IMF best practices.

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Actually, there is much more to disinvestment proceeds being categorised as a revenue, over and above the IMF best practices. In the recent past, the government has sold its stake in one company to another government company, and categorised that as revenue. If the overall control and stake of the government continues to remain the same, how is that disinvestment? Can someone please explain that to me?

Also, when one government owned company buys another, it ends up borrowing money in order to carry out the deal. In this way, the debt which should have been on the books of the government ends up on the book of a corporation. Hence, it is not a part of the fiscal deficit.

There are other points that the Comptroller and Auditor General (CAG) has raised in a recent report. The government, in the recent past, has resorted to off-budget financing, the CAG report suggests.

As the report points out: "In terms of capital expenditure, off budget financing of railway projects through borrowings of the IRFC [Indian Rail Finance Corporation] and financing of power projects through the PFC [Power Finance Corporation] are outside the budgetary control. Such off-budget financing are not part of calculation of the fiscal indicators despite fiscal implications."

Let's look at these issues in slightly more detail. As of March 31, 2017, IRFC had a long-term borrowing and a short-term borrowing amounting to Rs 96,710 crore and Rs 5,769 crore, respectively. The total borrowing amounted to more than Rs 1,00,000 crore. This borrowing did not end up on the books of the government, which the CAG believes it should have.

As the CAG report points out: "It is understood that the credit rating agencies consider the ownership of IRFC by Government of India, its functioning under Ministry of Railway, favourable lease agreements with Indian Railways protecting net interest margin, and transfer the interest and foreign exchange risks on its borrowings to Railways. International rating agencies also recognize that IRFC's credit profile is inseparable from the Government's credit profile and bank on "almost certain" likelihood of Government of India extraordinary support to IRFC in events of financial distress."

What does this mean in simple English? The IRFC issues bonds to raise money to finance projects of the Indian Railways. The rating of these bonds is influenced by the fact that the government backs IRFC. As the CAG report points out: "Ministry of Railways provides letters of undertaking (LoU) to foreign lenders stating that in the event of IRFC falling short of funds to redeem the bonds on maturity and/or to repay the term loans owing to inadequate cash flows during the year, Ministry of Railways shall make good such shortfalls."

Basically, once you consider these points, it is pretty straightforward that given the ultimate risk of IRFC is borne by the government, then its bonds should also form a part of the borrowing of the government. In that sense, the interest paid on these bonds and their repayments made in a given year, should be a part of the expenditure of the government in that year, which it currently isn't. And that's wrong.

Now let's take the case of Power Finance Corporation. As of March 31, 2017, the PFC had a long-term borrowing and a short-term borrowing amounting to Rs 2,00,187 crore and Rs 2,401 crore, respectively. Thus, the total borrowing of PFC was more than Rs 2,00,000 crore. As of December 2018, the government owned 61.5% of the company.

As the CAG report states: "PFC is a nodal agency for various Government of India schemes such as Ultra Mega Power Projects (UMPPs) and Integrated Power Development Scheme (IPDS) for the development of the country's power sector. PFC is strategically important for achieving the Government's objective of augmenting power capacity across the country. PFC provides loans for a range of power-sector activities, including generation, distribution, transmission, and plant renovation and maintenance."

In order to provide these loans, it issues bonds to raise money. These bonds are rated by different credit rating agencies. And the fact that PFC is basically a quasi-government enterprise, comes into play regularly.

As the CAG report points out: "PFC's rating by international rating agency Moody's is in line with the rating for the Government of India due to its linkage with the Government, given the latter's ownership, as well as the strategic role it plays in the Government's plans for the power sector."

A similar point is made by CAG when it comes to the rating agency Fitch. As the report says: "Similarly, while assigning rating to PFC, international rating agency Fitch noted that PFC's ratings reflect its strong operational and strategic ties with the Government of India as the company plays an important role in developing and financing power sector utilities in India." The CAG makes similar points with respect to other rating agencies, which rate PFC bonds, as well.

Given this, PFC's debt should reflect on the books of the government of India as well, which it currently doesn't.

Over and above this, the government in 2016-2017, had also managed to postpone the payment of fertilizer and food subsidies, which needed to be paid during the course of the financial year to the next financial year.

The payment not made is referred to as a carryover liability, and it amounted to Rs 1,20,360 crore. This meant that Food Corporation of India (FCI) and the fertiliser companies had to borrow money from other sources to keep themselves going. Hence, borrowing that should have ended up on the books of the government, ended up on the books of FCI and fertiliser companies.

To conclude, the fiscal deficit of the government would be much more than what it currently is, if these factors are taken into account. Hence, to that extent the fiscal deficit of the government is much more creative than even creative accounting. And as the late Atal Bihari Vajpayee used to say: "Ye acchi baat nahi hai (this is not a good thing)."


Vivek Kaul
Vivek Kaul
Editor, Vivek Kaul Publishing

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Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

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3 Responses to "The Govt's Fiscal Deficit is Much More Creative Than Just Creative Accounting"


Jan 29, 2019

Cheating ourselves.... aka... Fair and Lovely


Ravindra Kango

Jan 29, 2019

This kind of window dressing or painting more rosy of the country's economy is quite common in the so called developed nations as well. In my view, the total amount taken outside the union budget is very small fraction of the whole budget and the government (i. e. the rulers) think it as a "managable" task. During my association with Equitymaster for last 3+ years I have noted one great contradiction: Your team of young researchers like Richa Agarwal, Rahul Shah, Tanushree Bannerjee work hard several months and regularly come up with various attractive recommendation services like Hidden Treasure, Exponential Profits, Rebirth of India, etc. You pitch members to subscribe to them for which bright pictures of the specific industry and Indian Economy in general are described which reveals positive effects of Demonetisation, GST, rapid growth of infrastructure, e-governance, Jandhan, Make In India, Digitise India, etc. At the same time, Vivek Kaul never saw anything positive but more and negative factors in all the above initiatives taken by the current government. He is trying to prove that all the above steps were only failures which paints and maitains very gloomy, pessimistic future of Indian economy, politics, education, health etc. If that much bad is going to happen, on what basis you go on introducing new recommendation services ? It is general knowledge that evrery government will do some jugglary of numbers to convince the people that all is well. Vivek's letters, in my view are sending wrong messages to your millions of customers, contradicting the youngsters in your team.

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Vipul Gor

Jan 29, 2019

If u add liabilities of Govt owned companies to Govt then Assets and all incomes need to be added proper it is?

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