GOVERNMENT BUDGETING AND FISCAL POLICY

GOVERNMENT BUDGETING AND FISCAL POLICY

BUDGETING IN INDIA

Budgeting is the process of estimating the availability of resources and then allocating them to various activities of an organization according to a pre-determined priority. In most cases, approval of a budget also means the approval to various spending units to utilize the allocated resources. Budgeting plays a crucial role in the socio-economic development of the nation.

Constitutional Provisions of Budgeting

Article 112: The Union Budget of a year is referred to as the Annual Financial Statement (AFS).

Importance of Budgeting

1. Political
   • Tool of legislative control: Budget is the most important tool of legislative control over the public purse. It signifies that no tax can be collected without prior authorization and no expenditure can be incurred without its prior approval.
   • Administrative management: It serves as a powerful tool of coordination and acts as a device to eliminate duplication and wastage. It is done by justification of estimates, supervision of the use of appropriated funds, and regulating the expenditures.
   • Control over government: The budgets are an important part of maintaining control of a government’s finances and are a means of achieving financial accountability.
2. Economic
   • Reallocation of Resources: It helps to distribute resources keeping in view the social and economic conditions of the country.
   • Allowance or Tax concessions: The government gives allowance and tax concessions to manufacturers to encourage investment.
   • Direct production of goods and services: The government can take the production process directly if the private sector does not show interest.
   • Contributing to Economic Growth: A country’s economic growth is based on the rate of investment and savings. More government expenditure, more disposable income with the public, more will be economic growth.
   • Bringing Economic Stability: The Budget focuses on avoiding business fluctuations to accomplish the aim of financial stability.
   • Managing Public Enterprises: Many public sector industries are built for the social welfare of the people. The Budget is planned to deliver different provisions for operating such businesses and imparting financial help.
   • Reducing Regional Differences: It aims to reduce regional inequalities by promoting the installation of production units in the underdeveloped regions.
3. Social
   • Reducing Inequalities in Income and Wealth: Government aims to bring economic equality by imposing taxes on the elite class and spending the collected money on the welfare of the poor.
   • Providing employment: Industries operating in the public sector contribute immensely to providing employment to a lot of people and generating revenues.

 

Issues in Budgeting Process (As per 2nd ARC)

• Poor planning;
• No links between policy making, planning and budgeting;
• Poor expenditure control;
• Inadequate funding for operations and maintenance;
• Little relationship between budget as formulated and budget as executed;
• Inadequate accounting systems;
• Unreliability in the flow of budgeted funds to agencies and to lower levels of government;
• Poor management of external aid;
• Poor cash management;
• Inadequate reporting of financial performance;
• Poorly motivated staff.

 

Reforms needed to overcome the weakness

1. Reforms in Financial Management System: To improve transparency, greater accountability, streamlining the structure of the Government, and elimination of corruption.
   • For Example: Public Financial Management System with the objective of tracking funds released under all Plan schemes of the GoI, and real-time reporting of expenditure at all levels of Programme implementation.
2. Medium-term plan/budget frameworks: There is a need for aligning the annual budgets explicitly with the plans and with the accounting mechanisms so that there is a clear ‘line of sight’ between the medium-term developmental plan and the annual budget exercise.
   • For Example: FRBM Act provides for a medium-term expenditure framework.
3. Prudent economic assumptions: The tendency to be overly optimistic has to be avoided.
4. Top-down budgeting techniques: There is a need to shift from the traditional bottom-up approach to budgeting to a top-down framework where the desired outcomes should point to the resources required.
   • For Example: Outcome-based budgeting introduced in 2005-06 in India.
5. Transparency and simplicity: The budget documents should be simple and easy to comprehend and be available in the public domain.
   • For Example: An important feature of the 2021 Budget is the transparency on including off-budget items during the pandemic.
   • For Example: The FM took a step towards transparency by admitting to off-balance-sheet borrowings of 0.8 percent of GDP in the 2020 budget.
6. Adopting modern financial management practices: Modern financial management tools like accrual accounting, information technology, and financial information systems need to be used to improve decision making and accountability.
   • For Example: The government will use data analytics, AI, and Machine Learning to launch MCA 21 3.0, which will add the facility of e-scrutiny, e-consultation, compliance management, and e-adjudication among others.
7. Budgeting to be realistic: Unless the projections made in the budget are reasonably accurate, the budgetary exercise loses credibility.

 

Changes Introduced in 2017

• Advancement of Budget presentation to February 1 (earlier presented on the last working day of February).

• Merger of Railway Budget with the General Budget, and
• Doing away with plan and non-plan expenditure.

 

Way Forward

• Use of Technology: Like Big Data analytics and AI to streamline the budgeting process with more accurate figures.
• Follow FRBM Act: Government should directly follow the FRBM provisions to control government debt.
• Easy tax regime through budget: A structured and simplified tax regime would better help attract investment, thus enhancing infrastructure, industries, and growth.
• Budgetary control for performance evaluation: It is a powerful tool for management to ensure performance evaluation.
• Focus on output: An input-focused approach often takes a short-term view in budget decision-making, failing to account for longer-term costs.

Budgeting involves a large number of policy questions in the course of making fiscal decisions. It is much more than a mere policy statement of revenue and expenditure of the government. The government should focus on transparency and a more tech-driven budgeting process.

 

GREEN BUDGETING

Green Budgeting is a process that tries to include all environmental costs into the financial results of operations. GDP ignores environmental loss and degradation while calculating it, and therefore policymakers and the government need a revised model that incorporates these through green accounting.

The first solid impetuses for Green Budgeting came into Agenda 21 and the Brundtland Report, emphasizing the need to “ensure the coherence of economic, social, sectoral, and environmental policies, and plans instruments, including fiscal measures and the budget.”

Need of Green Budgeting in India

1. Vulnerable: India is considered one of the most vulnerable countries to climate change hazards like floods, drought, landslides, and sea-level rise.
   • According to The Germanwatch Global Climate Risk Index-2021, India was ranked 7th, implying an extremely high exposure and vulnerability.
2. Climate change: Climate change can have a negative and disastrous impact on food security, farming, forests, water resources, marine biodiversity, coastal areas, livelihoods, and health, severely affecting Indian people.
3. Effect on economy: Climate change strongly influences India’s economic development.
   • For example: A 1°C increase in temperature can reduce the growth of median emerging market economies by 0.9% in a year.
4. Dependence on forest economy: India’s tribal population has a significant dependence on forest resources.
5. Agrarian economy: India is still a predominantly agriculture-based economy, with 50% of the population directly or indirectly dependent on agriculture for employment.

 

Importance

1. Environmental
   • Better use of natural resources: Making the budget green is about integrating them into every aspect of our economy and ensuring that there is no wasteful and undesired use of natural resources.
     • For Example: According to NITI Aayog, blending of 15% methanol in gasoline can result in at least a 15% reduction in the import of gasoline/crude. In addition, it would bring down GHG emissions by 20%, thereby improving urban air quality.
   • Better targeting: The main idea of having green accounting is to help understand the advantages of achieving traditional and desired economic goals in alignment with environmental goals.
   • Sustainable development: It provides the assurance that not only the present but also future generations are hazard-free and safe.
2. Economic
   • Reduce fiscal deficit: Integrating environmental information and better usage of natural resources, fines, and taxes for dirty carbon can provide increased government resources and income, while also reducing government spending on efforts to reduce air pollution.
     • For Example: In the 2016 Budget, an attempt was made to discourage the use of “dirty coal” through an increase in the clean energy cess from ₹100 to ₹200 per ton of coal to finance clean environment initiatives.
   • Integrated budget: It includes all the dimensions of sustainable development (ecological balance, social progress, and economic growth) completely integrated into a single policy that is the budget document.
   • Long-term benefit: Planning and investing in the green economy will have long-term benefits, as it not only reduces destruction but also prevents future catastrophes, which may be costly.
     • For Example: The Center for International Forestry Research estimates that families living in and around forests derive an average of one-fifth to one-fourth of their income from forest-based resources.
   • Tribal economy: Non-timber forest resources are of great significance for the tribal economy in India.
     • For Example: The FAO estimated in 2005 that the value of non-timber forest products extracted from forests worldwide amounted to $18.5 billion.
3. Governance
   • Better Policies: It increases the related information available for analyzing key policy issues, often overlooked. This leads to better policies based on data in a holistic and integrated manner.
     • For Example: Methanol cook stoves can result in a minimum of 20% savings for households in comparison to LPG. After significant success at the pilot scale, the methanol cooking program is being scaled up to 1 lakh households by 2019 in the states of U.P., Maharashtra, Gujarat, Telangana, A.P., Goa, Karnataka, Jharkhand, and Manipur.
   • Research and development: Green budgeting helps promote a sustainable future for businesses by bringing green research and development and green public procurement into the big picture.

 

Challenges

• Lack of resources: In a country like India, we are still in a developmental phase, which requires a lot of resources for other key areas too.
• Low motivation: Most developed countries or historical polluters are insensitive toward climate, which demoralizes developing countries.
• Other challenges: In India, there is still widespread malnutrition and poverty, which is important for the government in terms of budgetary allocation.
• Long-term investment: The green economy will benefit in the long term, while there is cut-throat competition among economies today.
• Lack of assessment: Developing countries still lack proper technology for assessing the impact of the green budget allocated.

 

Budget 2022 Commitment toward Green Economy

• Solar energy commitment: The measures include an increased allocation of ₹19,500 crores for the Production Linked Incentive (PLI) scheme for domestic manufacturing of solar modules, aiming to achieve 280 GW of installed solar capacity by 2030.
• Biomass pellets in thermal power plants: The proposal to co-fire 5-7% biomass pellets in thermal power plants will result in carbon dioxide reduction, provide income to farmers, and aid in the reduction of stubble burning.
• Battery swapping policy: To boost the Electric Vehicles (EV) ecosystem, a battery swapping policy has been announced, emphasizing the need for interoperability standards.
• Energy Service Company: On the energy efficiency front, the development of an Energy Service Company (ESCO) business model in large commercial buildings will support capacity creation, energy audits, performance contracts, and a standard framework for measurement and verification.

 

Way Forward

• Better implementation: The government should not merely propose laws but also ensure their efficient implementation.
• Efforts at all levels: The budget emphasizes that much more needs to be done not only at the central level but also at the state level.
• Exploring “All”ternatives: Instead of sticking to one alternate resource, other sources should be explored to contribute more to the green economy.
• Capacity building: Efforts should focus not only on awareness but also on building the capacity of industries in green technology to establish manufacturing and create more job opportunities.
• Protection fund: The government can establish a Green Protection Fund to protect wildlife, support front-line forest protection forces, maintain forest belts, ensure free-flowing rivers without garbage, and enhance biodiversity protection.

We are still a long way from fully integrating green concerns into all aspects of the economy or gaining recognition from politicians that investing in the environment benefits the economy. The UNEP’s Green Economy Report suggests that “a strategy of reallocating investments towards the green economy may lead to slower potential economic growth for a few years, as renewable natural resources are replenished (an effect that can be strong in some sectors, such as fisheries), but will result in long-term faster economic growth.” The report also highlights other economic benefits as it reduces risks associated with climate change, energy shocks, and water scarcity while creating increased employment.

 

ISSUES RELATED TO PLANNING

• Planning is the procedure of thinking about and organizing the actions required to realize a desired goal. Planning involves the formation and maintenance of a plan.
• India is a vast country with multiple problems faced by its population. The British ruled the country for nearly two centuries and exploited its resources for their benefit, leaving the country reeling under absolute poverty. When the British left India in 1947, there was nothing to be proud of or happy about except for the ‘freedom.’
• The problems were many before the Indian government. Besides mass poverty, there was the problem of food shortage and inflation. Illiteracy, lack of healthcare, lack of infrastructure, etc., were other serious problems facing the country. As a long-term strategy, ‘planning’ for economic development was the answer to solve these problems.
• Inspired by the Russian experience, planning as an instrument of economic development was adopted. The Planning Commission was set up to prepare five-year plans that would indicate directions in which the Indian economy should move. Resources were to be allocated both at the Centre and in the States according to the plan priorities decided in a five-year plan.
• The basic objective of Indian planning has been the acceleration of economic growth to raise the living standards of the people. Further, various five-year plans also gave high priority to the generation of employment opportunities and the removal of poverty.

 

History of Planning in India

• 1938 – National Planning Committee: Set up by Subhash Chandra Bose and Jawaharlal Nehru. But the reports of the committee came out only after 1947.
• 1944 – Bombay Plan: Set up by 8 industrialists of Bombay, including JRD Tata. It envisaged doubling the per capita income and tripling the national income in 15 years.
• 1945 – People’s Plan: Drafted by MN Roy based on Marxist socialism. Nationalization of all agriculture and production was the main feature of this plan.
• 1947 – Planning Commission: For assessing resources in the country, augmenting deficient resources, and formulating plans for the most effective and balanced utilization of resources.
• 1950 – Sarvodaya Plan: Drafted by JP Narayan. It emphasized agriculture, small and cottage industries, land reforms, and decentralized participatory planning.
• 1952 – National Development Council: To support the Five-Year Plans made by the Planning Commission, to promote common economic policies, and to ensure rapid development of all parts of the country.
• 2015 – NITI Aayog: To achieve Sustainable Development Goals (SDGs) by fostering the involvement of State Governments of India in the economic policy-making process using a bottom-up approach.

 

Process of Planning

1. Preparing the list of economic problems
2. Rearranging it on the basis of priority
3. Identifying the problems to be solved in the short run and over the long run
4. Mobilizing the resources
5. Estimating the amount of resources needed
6. Fixing a target to achieve the desired goal
7. Implementation and execution to achieve the desired goal

 

Five Year Plans

YEAR	OBJECTIVE	ASSESSMENT
1st FYP  1951-1956	Rehabilitation of refugees, rapid agricultural development to achieve food self-sufficiency in the shortest possible time, and control of inflation.	Targets and objectives were more or less achieved. With an active role of the state in all economic sectors, five Indian Institutes of Technology (IITs) were started as major technical institutions.
2nd FYP 1956-1961	The Nehru-Mahalanobis model was adopted, emphasizing the development of basic and heavy industries. Industrial Policy of 1956 accepted the establishment of a socialistic pattern of society as the goal of economic policy.	It could not be fully implemented due to the shortage of foreign exchange. Targets had to be pruned. However, hydroelectric power projects and five steel mills at Bhilai, Durgapur, and Rourkela were established.
3rd FYP 1961-1966	Aims to establish a self-reliant and self-generating economy.	Though it failed due to wars and droughts, Panchayat elections were started, and state electricity boards and secondary education boards were formed.
Plan Holidays – Annual Plans  1966-1969	Aims to tackle the crisis in agriculture and serious food shortages.	A new agricultural strategy was implemented, involving high-yielding seed varieties, extensive fertilizer use, exploitation of irrigation potential, and soil conservation measures.
4th FYP 1969-1974	Aims to achieve ‘growth with stability’ and progressive self-reliance. ‘Garibi Hatao’ was also an objective. Target: 5.5%.	It was ambitious but marred by inflation. The Indira Gandhi government nationalized 14 major Indian banks, and the Green Revolution in India advanced agriculture.
5th FYP 1974-1979	Start with the objective of ‘Removal of poverty and attainment of self-reliance.’	High inflation led to its termination by the Janta government. However, the Indian national highway system was introduced for the first time.
6th FYP 1980-1985	Direct attack on the problem of poverty by creating conditions of an expanding economy.	Most targets achieved. Growth: 5.5%. Family planning was also expanded to prevent overpopulation.
7th FYP 1985-1990	Emphasis on policies and programs that would accelerate growth in food grains production, increase employment opportunities, and raise productivity.	With a growth rate of 6%, this plan proved successful despite severe drought conditions for the first three years. This plan introduced programs like Jawahar Rozgar Yojana.
Annual Plans 1989-1991	No plan due to political uncertainties.	It was the beginning of privatization and liberalization in India.
8th FYP 1992-1997	Rapid economic growth, high growth of agriculture and allied sectors, growth in exports and imports, improvement in trade, and current account deficit. Target: 5.6% average growth.	Partly successful. An average annual growth rate of 6.78% was achieved against the target of 5.6%.
9th FYP 1997-2002	Quality of life, generation of productive employment, regional balance, and self-reliance. Growth with social justice and equality. Growth target: 6.5%.	It achieved a GDP growth rate of 5.4%, lower than the target. Industrial growth was 4.5% (higher than the target of 3%), and the service industry had a growth rate of 7.8%. The average annual growth rate reached 6.7%.
10th FYP 2002-2007	To achieve 8% GDP growth rate, reduce poverty by 5 points, and increase the literacy rate in the country.	Successful in reducing the poverty ratio by 5%, increasing forest cover to 25%, increasing literacy rates to 75%, and achieving economic growth over 8%.
11th FYP 2007-2012	Rapid and inclusive growth. Empowerment through education and skill development, reduction of gender inequality, environmental sustainability. Targeted growth rates: agriculture 4%, industry 10%, services 9%. Provision of clean drinking water for all by 2009.	India recorded an average annual economic growth rate of 8%. Farm sector growth was 3.7% (against a 4% target), while the industry grew with an annual average growth of 7.2% (against a 10% target).
12th FYP 2012-2017	Aimed for “faster, sustainable, and more inclusive growth.” Targeted agriculture output growth at 4%, manufacturing sector growth at 10%, and adding over 88,000 MW of power generation capacity.	The growth rate target was 8%.

 

Need for Planning in India

1. Economic

• Accelerating economic growth: To accelerate economic growth, economists recognized that raising the rate of saving and investment was essential.
• Inadequacy of the private sector: The private sector alone could not achieve a higher rate of saving and investment required to break the vicious circle of poverty.
• Emphasis on industrialization: The private sector, driven by profit motive, could not be expected to allocate sufficient resources to the growth of capital goods industries.

• Growth of basic heavy industries: The role of planning and the public sector is essential for the rapid growth of basic heavy industries.
• Role of agriculture: State planning is necessary for land reforms in agriculture, providing adequate credit to farmers, and developing infrastructure such as irrigation, power, and roads.

2. Regulatory

• Compensate market failures: The market mechanism was inefficient in allocating resources over time for investment. Planning helps allocate resources for investment to foster rapid economic growth.
• Regulatory role of the state: To achieve optimal resource allocation among industries according to plan priorities, economic activities in the private sector needed regulation by the State.

3. Development

• Tackling the problems of poverty and unemployment: Planning was necessary to initiate and implement special poverty and unemployment schemes like the Food for Work Programme and Employment Guarantee Schemes to support the poor and weaker sections of society.

 

Objectives for Planning in India

1. Economic

• Economic development: To achieve a higher standard of living for each individual and household, as well as society overall, per capita income and national income must grow in real terms.
• Economic stability: To maintain stable market conditions by keeping inflation low and preventing deflation.
• Increased levels of employment: To better utilize the country’s human resources by increasing employment levels.
• Modernization of the economy: To transform the GDP structure by improving human resources and developing industries and the service sector.
• Self-sufficiency: India aims for self-sufficiency in major commodities and to increase exports through economic planning. The Indian economy reached the take-off stage of development during the third Five-Year Plan (1961-66).

2. Social

• Social welfare and provision of efficient social services: To increase labor welfare and social welfare for all sections of society. The development of social services such as education, healthcare, and emergency services has been part of planning in India.
• Reduction in economic inequality: Measures to reduce inequality through progressive taxation, employment generation, and job reservations.
• Ensuring social justice and equality: To reduce the population living below the poverty line and provide access to employment and social services.
• Increased standard of living: To raise the standard of living by increasing per capita income and ensuring equitable income distribution.

 

3. Developmental

• Regional development: Economic planning in India aims to reduce regional disparities.
  • Example: States like Punjab, Haryana, Gujarat, Maharashtra, and Tamil Nadu are relatively well-developed, while states like Uttar Pradesh, Bihar, Odisha, Assam, and Nagaland lag economically.
• Comprehensive and sustainable development: Development of all economic sectors, including agriculture, industry, and services.

• Failure to Remove Poverty and Inequality completely: No significant improvement in the distribution of income and asset holding has resulted in persistent inequality, with concentrated economic wealth and power in the hands of a few.
• Problems of unemployment: According to official estimates, India’s unemployment rate is 6.6%, with a large backlog due to the lack of sufficient job creation each year.
• Not understanding ground realities: Policies by NITI Aayog are criticized for being based on a “One size fits all” approach, showing a lack of awareness of ground realities and limited experience in achieving practical outcomes.
  • Example: Unrealistic data on poverty lines.

2. Political

• Alliance politics affects planning: To meet the financial demands of coalition partners, governments often compromise on fiscal prudence.
• Constitutional status: Neither NITI Aayog nor the former Planning Commission is a constitutional body.

3. Administrative

• Central in nature: Planning was largely centralized, with decentralized planning still in nascent stages.
• Lack of reach of policies: Centralized planning often does not extend effectively to peripheral areas.
• Duplication of effort: The Planning Commission had, at times, taken over roles designated for the Finance Commission.
• Complex system problem: The economy, society, and natural environment are interconnected. Issues in one part can impact the whole system.

4. Federal

• Conflicting objectives: States are expected to improve human development, create infrastructure, and manage their financial resources efficiently, all while balancing budgets.
• Financial insufficiency: Most Indian states are not financially self-sufficient and rely on central grants as determined by the Finance Commission, where states have no representation.
  • Example: Providing skills to millions of youth before enough employment opportunities exist may backfire.

5. Economic

• Underground economy: A significant portion of India’s GDP is unaccounted for, leading to a lack of transparency in decision-making and transactions.
• Role of NITI Aayog: Concerns have been raised about NITI Aayog’s independence, with some viewing it as a mouthpiece for the government.
• Rent-seeking behavior: Political and bureaucratic executives may amass monopolistic and discretionary powers for resource allocation.

 

Achievements of Planning

• Achievements in economic growth: Expansion in transport and communications, growth in electricity generation, progress in steel, aluminum, engineering goods, chemicals, fertilizers, and petroleum products, and increased per capita availability of consumer goods.
• Creation of infrastructure: Expansion of roads and railways, growth in domestic air travel, expansion of irrigation and hydro-electric projects, urbanization with more towns and cities, and development of mobile telephony and internet networks.
• Development in education: Increased school enrollment and establishment of 378 universities and 18,064 colleges in India.
• Development of science and technology: Growth in technical and skilled manpower, reduced reliance on foreign expertise, and advancements in space research and nuclear energy.

• Expansion of foreign trade: Decrease in dependence on the import of capital goods and increase in the export of manufacturing and engineering goods.

 

Way Forward

1. Structural
   • Redefine role of NITI Aayog: It should act as a force for persuasion, not a control center, and should aim to promote local solutions to national problems.
   • Multi-stakeholder approach: Multiple stakeholders should be involved in implementing a plan in a large, diverse, and democratic country.
   • Transformational approach to 21st-century challenges: New methods are required to enhance ‘organizational learning’ among stakeholders, who must plan and implement solutions together.
2. Administrative
   • Devolution of responsibility: Planning should be devolved to state governments and even to the third tier of city and district governance.
   • Need for diversification in policy-making: National planning institutions should support growth that is economically faster, socially inclusive, and environmentally sustainable.
   • Qualitative and quantitative aspects of planning: Both qualitative and quantitative aspects need attention to ensure the benefits of development are widely shared.
   • Renewal of civil services: Ensuring the long-term affordability of civil services by enforcing procedures that reward merit and discipline misconduct, to strengthen accountability and improve performance quality.
   • Governance reforms: Governance should be structured to enhance transparency, accountability, and streamline the government structure.
3. People Participation
   • Better information dissemination: Improved transparency should increase the flow of information to the public, reducing arbitrariness and allowing decisions to undergo closer scrutiny.
   • Public participation: Decentralization is necessary for public participation in planned development. The implementation of the 73rd and 74th Constitutional Amendments of 1993 must be enforced in both letter and spirit.

Four decades of planning explains that India’s economy, a mix of public and private enterprise, is too huge and diverse to be completely responsive or predictable to directions of the planning authorities. Real results generally differ in important respects from plan targets. Major inadequacy includes deficient improvement in income distribution and mitigation of poverty, delayed completions and cost overruns on many public-sector projects, and far too little a return on numerous public-sector investments. Despite the fact that the plans have turned out to be less effective than expected, they help guide investment priorities, policy recommendations, and financial mobilization.

ISSUES OF DEVELOPMENT

• India has been experiencing a consistently high growth rate during the post-liberalization period following the implementation of economic reforms in the early 1990s. It has achieved excellence in several key areas, ranging from information technology and pharmaceuticals to automotive parts, and is now considered one of the fastest-growing economies in the world.
• Despite these positive developments, India is still among the countries with some of the lowest indicators of human development. Levels of malnutrition, illiteracy, and poverty are high. The rise in income inequalities and regional disparities is also a concern. Employment has grown, but the jobs created are of low quality. Although there has been an expansion in several social services like health, nutrition, and education, the quality of most of these services remains poor, especially in rural areas. Moreover, an overwhelming majority of the population lacks basic social protection. Policymakers face a paradox—the persistence of deprivations and increasing insecurities among a large section of the population amidst growing affluence for some.

 

Issues of Development

1. Economic issues

• Growth concerns: India’s growth is primarily driven by the service sector. The manufacturing sector remains sluggish, and agriculture is still heavily dependent on the monsoon.
• Agriculture sector: Nearly 50% of the population depends on agriculture, which contributes only 14% of GDP.
• Lack of investment: High growth requires investment in productive areas and supporting infrastructure, which India lacks.
• Broadening Current Account Deficit: India reported a current account surplus of 0.9% of GDP in the pandemic-hit FY21, compared to a deficit of 0.9% in FY20, according to RBI data.
• Widening fiscal deficit: For funding welfare schemes, subsidies, and defense expenditure, India is borrowing.
• Non-inclusive growth: In 2011, 21.9% of India’s population lived below the national poverty line. By 2018, almost 8% of the world’s workers and their families lived on less than $1.90 per person per day (international poverty line).

2. Statistical issues

• Components of poverty line basket (PLB): Price differentials for basket constituents vary by state and period.
• Lack of consensus among states: Some states, like Odisha and West Bengal, supported the Tendulkar Poverty Line, while others like Delhi, Jharkhand, and Mizoram supported the Rangarajan report.
• Poverty line is drawn too low: The current official poverty line, based on the Tendulkar line, is set at ₹27.2 in rural areas and ₹33.3 in urban areas.
• Demographic and economic dynamics: Consumption patterns, nutritional needs, and component prices vary according to macroeconomic and demographic dynamics.
• Problem of determining threshold: If the poverty threshold is set too high, many needy people may be excluded; if set too low, it can strain government finances.

3. Climatic issues

• Reduced the capacity of people: India’s hot climate reduces people’s work capacity, especially in rural areas, which severely affects productivity.
• Disaster: Frequent floods, famines, earthquakes, and cyclones cause significant damage to agriculture, leading to food price increases and restricted access, putting many at higher risk of hunger.
• Water contamination: Flooding can contaminate water sources, increasing the spread of water-borne diseases like Typhoid and Cholera.
• Dependence on monsoon: The absence of timely rain, or excessive or deficient rainfall, severely affects the country’s agricultural production.

4. Demographic issues

• Reduction in per capita: Population growth increases poverty by lowering per capita income.
• Lower wage rate: Rapid population growth increases labor supply, which tends to lower wage rates.
• Size of family: Poor families may prefer larger families for agricultural support and future security, often without awareness of family planning methods.
• Incidence of poverty: Larger family sizes lead to lower per capita income and lower living standards.

5. Political issues

• Communal tensions: Conflicts between regional parties disrupt processes for concessions and poverty alleviation.
• Delayed reforms: Rural reforms are often stalled indefinitely or implemented as half-measures, with limited impact on poverty reduction.
• Exclusion: Political leaders sometimes exclude large portions of the population from poverty censuses, often leaving out minority ethnic groups, tribal communities, and Dalits from beneficiary lists.
• Vote bank politics: Development plans are often influenced by political interests, which hampers effective poverty and unemployment reduction.
• Capital and able entrepreneurship deficit: A shortage of capital and entrepreneurship limits significant production increases.
• Lack of adequate housing: Housing for the poor remains a major national issue, with homeless populations facing even greater challenges.

6. Social issues

• Untouchability: Untouchability restricts general employment opportunities, relegating affected individuals to inhumane jobs like manual scavenging.
• Caste system: The caste system subordinates lower castes, preventing them from pursuing professions like business or trade.
• Slow development: Laws of inheritance, caste traditions, and customs hinder faster development, exacerbating poverty.
• Lack of education: Poverty is closely related to education levels and vocational skills. For instance, the literacy rate for female Dalits in Bihar is around 38.5%, which is approximately 30 years behind the national literacy rate.

• Inflation: The spending pattern of BPL (Below Poverty Line) people forces them to spend almost their entire income on basic necessities like food, clothing, and shelter, in that order.

 

Way Forward

1. Education

• Paradigm shift: Education policy should focus on improving school functioning and raising the quality of educational outcomes, beyond just enrollment.
• Inclusive education: A systematic school mapping exercise should be undertaken to provide marginalized groups access to both lower and upper primary classes, removing social barriers to education.
• Shared public space: Allow private schools to co-exist with government schools in delivering education.
• Standardization of schools: Ensure the provision of core inputs and a well-developed pedagogy.
• Bridging the gender gap: Set long-term goals to bridge the gender gap and universalize elementary education among girls.
• Public investment: Raise education sector allocation from the current 4% to the targeted 6% of GNP.
• Improved teaching inputs: Implement well-designed programs for recruiting, retaining, and deploying teachers in each state to maintain high teaching quality and clear vacancy backlogs at all levels.

2. Health

• Convergence of initiatives: Focus on broader healthcare determinants like food and livelihood security, drinking water, women’s literacy, nutrition, and sanitation.
• Focus on disease prevention: Prioritize clean water and sanitation over antibiotic treatment, necessitating public health specialist training and facility development.
• Financing of healthcare: Increase public health expenditure to about 2% over the next five years.
• Private healthcare providers: Establish regulations to ensure private sector adherence to ethical standards and treatment practices.
• Community participation: Train local community workers in basic healthcare, as Primary Health Centres (PHCs) cannot always serve as the first point of contact across India.

3. Nutrition

• Food production: Promote policies to increase food productivity, enhance land use, and encourage desirable cropping patterns to combat malnutrition.
• Restructure national-level programs: Facilitate the convergence of health, education, water, sanitation, and food security schemes at all levels.
• Food supplementation programs: Transfer resources to poor families, particularly targeting pregnant women, nursing mothers, children under five, schoolchildren, and adolescent girls.
• Convergence of various district plans: Departments like health, ICDS, sanitation, education, and local panchayats should ensure shared outcome indicators and department-specific outputs for all stakeholders.

• Continuous monitoring of nutrition indicators: For identifying areas of high malnutrition, measuring program outcomes, and documenting malnutrition trends.
• Women empowerment to reduce malnutrition: By ensuring higher levels of schooling for girls, delaying marriage, and supporting higher maternal age at the birth of the first child.
• Social mobilization: Informing communities about health and nutrition objectives and generating enthusiasm to encourage action, especially at family and local community levels.

4. Employment and Skills

• Unify policy of employment and growth: Reverse the government policy of separating employment creation from growth to address jobless growth in the organized sector.
• Focus on the unorganized sector: Improving labor productivity in the unorganized sector is crucial, as it impacts employment conditions in the organized sector.
• Skill the workforce: Develop training institutions and trainers, particularly for emerging trades where there is a significant shortage of skilled workers.
• Annual employment surveys: Assess the impact of outsourcing, a result of liberalization, which has boosted labor-intensive and skill-intensive exports, like Information Technology.
• Wages should be monitored: Examine labor market functioning and assess wage elasticity, especially after implementing Sixth Pay Commission recommendations.

5. Social Protection

• Reduce regional disparities: Address the social protection needs of groups such as migrant workers, the elderly, people with disabilities, and tribal communities to ensure higher economic growth.
• Effective method of identifying beneficiaries: Ensure universal coverage of beneficiaries while considering targeting costs.
• Dynamic method of BPL Census: Adjust methods to avoid perverse incentives created by premium status for groups eligible for social assistance.
• Effective participation of the people: Enhance accountability in social transfers and address economic and social equity, gender bias, and illiteracy at the grassroots level.
• Recognize the role of women as agents of change: Focus on eliminating gender gaps and empowering women to reduce poverty and inequality.
• Set up a Social Security Board: Organize stakeholders by occupation and consider informal workers’ needs to create a cost-effective system and address grievances effectively.
• Pro-poor policies at the macro level: Reverse the trend of post-reform macro-policies that have not been pro-employment or pro-poor.
• Inclusive governance: Social mobilization, community participation, and a decentralized approach are needed for effective implementation of social protection policies and programs.

6. Strengthening the social programs

• Performance-linked devolution: For effective fiscal transfers, devolution of central funds to states should be linked to a performance-oriented, quantifiable annual index based on agreed economic, social, health, and infrastructure-related indicators.
• Decentralized governance system: Panchayati Raj Institutions (PRIs) have become an important part of the decentralized governance system and can be empowered with greater decision-making power at the local level. Their eligibility for central funds should be linked to their ability to raise resources from internal sources.
• Participatory governance: Organizations representing marginalized groups (such as landless people, women, Dalits, and Adivasis) should be encouraged parallel to PRIs.

7. Poverty Eradication

• Redefining poverty lines: Poverty lines should be recalibrated based on changes in income, consumption patterns, and prices.
• Viable poverty line: The poverty line should ensure that households can afford two square meals a day and other basic necessities.
• Hybrid of absolute and relative measurement of poverty: This approach would aim to ensure an income that allows for a certain welfare status, including basic nutrition and social inclusion.
• Political economic equilibrium: Government spending should prioritize public goods over subsidies.

8. Decentralization of Governance

• Productivity of schemes: It is necessary to consider both redistribution and productivity effects of schemes, including asset redistribution, while assessing the welfare impact.
• Reasonable minimum standards: Standards in education, health, and other services should be established, with effective monitoring and surveillance systems to track outcomes.
• Decentralization and participatory programming: Local institutions and bodies, such as PRIs and SHGs (Self-Help Groups), should play a significant role in implementing programs effectively.
• Effective administrative mechanism for local governance: Ensuring prompt delivery of services, greater professionalism, better management, technological adaptation, and complementary administrative reforms.

India has become a significant player in the global economy, especially after its economic liberalization in the early 1990s, which shaped the global perception of India. Today, international communities are enthusiastic about working with India, seeing mutual benefit in this relationship. An IMF report notes that India continues to benefit from economic reform, although challenges remain, including issues related to population growth, low technology levels, and living standards. Mobilizing natural and human resources is essential to further economic development.

MOBILIZATION OF RESOURCES

Mobilization of resources means freeing up locked resources. Every country has economic resources within its territory that may not be available for collective use. The percentage of resources utilized relative to their potential is often very low. For a country to grow, identifying and mobilizing these resources is necessary. Resources should be easily accessible for both central and state-level planning.

Resource mobilization is a process that identifies essential resources for development, implementation, and continuity of efforts to achieve national missions. In practical terms, resource mobilization involves expanding relationships with resource providers and enhancing skills, knowledge, and capacity for optimal resource utilization.

Resource Mobilization

Types of Resources

1. Natural Resources: Naturally occurring substances that are considered valuable in their natural form. Their value is determined by the available amount and demand for them.
   • Examples: Land, water, sunlight, wind, minerals, etc.
   • Classification parameters: Natural resources can be classified based on various factors, such as:
     • Resources that require development and value addition.
     • Resources based on origin.
     • Availability and distribution of resources.
   • Classification: Natural resources requiring development can be further categorized into:
     • Based on development of resources:
       • Actual resources: Those surveyed, with determined quantity and quality, currently in use.
         • Example: Petroleum and natural gas from the Mumbai High Fields.
       • Potential resources: Known to exist and may be used in the future, such as petroleum in regions with sedimentary rocks.
     • Based on origin:
       • Abiotic resources: Composed of non-living things, e.g., land, water, air, gold.
       • Biotic resources: Derived from the biosphere, e.g., forest products, marine life.
     • Based on availability:
       • Renewable resources: Replenishable resources like sunlight, air, and wind.
       • Non-renewable resources: Resources that do not renew quickly enough for sustainable extraction, e.g., fossil fuels.
2. Human-made Resources: Created by humans using natural resources, such as paper, clothing, and high-tech products like computers and phones.
3. Human Resources: The people who form the workforce in an organization, contributing both tangible and intangible skills.
4. Debt Instruments: Borrowed funds that must be repaid with interest, e.g., loans and credit card debt.
5. Equity Instruments: Funds from stock sales, offering investors a return on investment.
6. Grants/Subsidies: Financial support provided by governments or aid agencies.

              

Need for Resource Mobilization

• Social security: The government plays a dominant role in controlling economic activities and ensuring the social welfare of people, which requires resource mobilization.
• Socialistic objective: Based on equality principles, aiming to provide equal opportunity to all and ensure equitable wealth distribution.
• Regulation of resources: Exercises control over economic activities. In a welfare state, private enterprises are regulated by the government.
• Providing basic facilities to citizens: A welfare government provides services like education, healthcare, public transport, housing, and financial assistance.
• Runs various enterprises: Government ownership and operation of industrial enterprises, businesses, and other commercial activities.
• Ensures justice for all: State responsibility includes justice and supporting common citizens in interactions with authorities.
• Regulation of private enterprises: Controls economic activities, including registration, licensing, and taxation.
• Welfare of laborers: State enacts laws to protect workers’ security and welfare across industries.

 

Sources of Resource Mobilization

1. Private sector resource mobilization:

• Banks: Primary financial institutions accepting public deposits and creating credit.
• Angel investors: Provide one-time or ongoing investments to support early-stage businesses.
• Innovation funding: A SEBI-registered venture capital fund focused on innovation-led, early-stage Indian firms.
  • Example: India Innovation Fund.
• Venture Capital (VC): Private equity for small, early-stage companies with high growth potential or growth records.
• Capital network: Covers all fundraising aspects, such as finding investors, pitching, due diligence, and exits.
• Cooperatives: Autonomous, member-owned organizations meeting economic, social, and cultural needs.
• Credit unions: Member-owned financial cooperatives providing financial services at competitive rates.
• International trade financing companies: Provide services like lending, issuing letters of credit, factoring, export credit, and insurance.

• Merchant bank: A company dealing mostly in international finance, business loans, and underwriting. These banks specialize in international trade, often working with multinational corporations.
• Finance and Leasing Association (FLA): The trade association for consumer credit, finance, and asset finance sectors.
  • Example: Banks, subsidiaries of banks, building societies, finance arms of retailers, manufacturing companies, and independent firms.
• Specialized financial institutions: These banks focus on financing specific economic and social sectors, such as small and cottage industries, commercial mortgage lenders, and specialized equipment financing.
  • Example: Export-Import Bank of India, Board for Industrial and Financial Reconstruction, Small Industries Development Bank of India, National Housing Bank.

2. Public Sector Resource Mobilization

• Direct taxes: Taxes paid by households and companies to government agencies, including income tax, payroll tax, and corporate profit tax.
• Indirect taxes: Taxes paid via a third party (e.g., retailer), based on purchases and services, including value-added tax, sales tax, excise tax, and import duties. Many have been consolidated under GST.
• Non-tax revenues: Earnings from state-owned enterprises, including natural resources like oil and gas.
• Financing from external (foreign) sources: Considered “public” when funds flow through recipient governments.
• Savings and investments: Important resources for mobilization.

 

Government Organisations

• National Development Council: Strengthens and mobilizes resources for national development, promoting a common economic policy.
• Finance Commission: Article 280 of the Indian Constitution establishes a mechanism for resource transfers from the center to states.
• State Finance Commission: Provides recommendations on resource claims by state governments, adding stability to the transfer process.

 

Issues in Mobilization of Resources

1. Structural

• Less domestic investment: Despite a high savings rate, Indians often invest in non-productive assets like gold instead of agriculture, manufacturing, or services.
• Weak fiscal policies: Fiscal indiscipline and deficit financing often hinder development in developing countries.

• Weak domestic taxation: The tax system is not broad-based, and tax evasion is common in developing countries, limiting public expenditure.

2. Economic

• Limited domestic public resources: Least developed countries (LDCs) rely heavily on external resources, which restrict their policy space and increase dependency. Economic vulnerability is further exacerbated by debt.
• Lack of rural banking penetration: While India has large national and international banks, financial inclusion at the rural level remains limited.
• Illicit financial flows from developing countries: These involve illegally obtained, transferred, or used resources, indicative of deeper structural governance issues.

3. International

• Lack of international tax cooperation: In a globalized world, tax systems in some countries affect public revenue collection in others.
• Flourishing tax havens: High-net-worth individuals often evade taxes by placing assets in tax havens.
• Lack of multilateral development banks: Institutional investors currently manage $115 trillion in assets, mostly in low-return developed country securities.

 

Way Forward

• Empower human resources: Weaker sections, such as women, children, SC, ST, and OBC groups, should be integrated into the mainstream.
• Utilize the demographic dividend: Employment opportunities must match human resources, with skill development programs where needed.
• Widen the tax base: Increasing the tax-to-GDP ratio will support fiscal consolidation and align tax collection with budget targets.
• Exploring factors of production: Land, labor, capital, and organization should come together to foster growth and investment.
• Initial resource mix: Starting organizations need access to technology, labor, capital, societal support, and legitimacy.
• Domestic Resource Mobilization (DRM): High-growth economies often save 20-30% of income to fund investments, potentially aligning with domestic ownership more than external resources.

Resource investment is critical for growth. Resource mobilization to boost investment involves choosing major investments, controlling expenditures, monitoring performance, and achieving planned economic activity. It also includes preventing tax evasion and avoidance.

 

GOVERNMENT DEBT

India’s public debt (combined liabilities of the Central and State governments) to gross domestic product (GDP), at constant prices, increased to a record high of 100.86 percent in 2020, up from 76.86 percent in 2014, according to data from the Reserve Bank of India.

 

Current Incidence Target for reduction: The government has announced a reduction in its gross borrowing target for the financial year 2022-23 by Rs 10,000 crore to Rs 14.21 lakh crore. Highest amongst Developing economies: According to Moody’s Investors Service, India’s public debt level is among the highest in emerging economies, with a quantitative easing programme underway, while its debt affordability is among the weakest. Demand for flexibility by states: Recently, the State government of Kerala has sought flexibility under the FRBM Act. Fiscal deficit: It has increased to 9.3% of GDP in the 2020-2021 fiscal year, up from 3.8 percent in the previous fiscal year. Data Government Debt to GDP in India: Averaged 68.51 percent of GDP from 1980 to 2020. Government liabilities accounted for 56.29 percent of the country’s GDP in 2021-22. India’s external debt to GDP ratio: Was 17.1 percent in 2006, rose to 23.9 percent in 2014, and has since decreased to 19.9 percent in 2022, the same as in 2019. Average interest cost: Remained constant at 7.1% for the Centre from 2017-18 to 2018-19. Liabilities: Approximately 94% of the Centre’s liabilities consist of domestic debt.

 

FRBM Act (N.K. Singh Committee)

1. Suggestion target: Recommended using debt as the primary target for fiscal policy.
2. Debt to GDP Ratio: Should be 38.7% for the central government and 20% for state governments by FY 2022-23.
3. Fiscal deficit: By FY 2022-23, the fiscal deficit should be 2.5% of GDP.
4. Escape clause in the event of:
   • National calamity, war, national security concerns, agricultural collapse affecting incomes and outputs.
   • Structural reforms in the economy with fiscal implications.
   • A decline in real output growth of at least 3% below the average of the previous four quarters.

 

Causes

• COVID-19: Relief packages have raised India’s public debt ratio to 90% of GDP.
• Increase in US federal rates: Resulted in capital outflows from developing countries worldwide to the US.
• Rise in Guarantees: Especially for MSME loans and other contingent liabilities.
• Lack of economic activities: Lockdowns led to a lack of economic activities.
• Lower GST collections: The Centre’s reduced GST collection impedes revenue-sharing with debt-ridden states.
• Custom Duty Waivers: Government granted waivers for key COVID-19 imports, reducing tax revenue.

 

Impact of Government Debt

1. At Macroeconomic level
   • Inflation: Higher government debt would require monetization, increasing the money supply in the economy, which results in inflation.
   • Credit Ratings: High debt lowers credit ratings, reducing investor interest in India and leading to low FDI inflows.
   • Intergenerational Equity: Government debt can create risks and costs for future generations.
   • Crowding out: As banks lend more to the government due to its debt, the private sector has less access to credit.
   • Capital flight: High debt may cause investors to fear a potential default, leading to capital outflows.
2. At Microeconomic Level
   • Higher Taxation: Higher interest payments lead to increased taxes and spending cuts.
   • Lower Spending: Debt obligations require spending cuts, reducing household incomes.
   • Impact on Welfare: The state’s ability to fund welfare schemes decreases, impacting vulnerable populations.
   • Unrest: High debt may lead to political instability and unrest.

 

Advantages and Disadvantages of Public Debt

1. Advantages of Public Debt
   • Economic Development: Enables underdeveloped countries to pursue economic growth.
   • Harmony: Equal and suitable debt distribution promotes harmony and cooperation.
   • Control on Natural Calamities: Government can use public debt to manage natural calamities.
   • Successful War Conduction: Debt is essential for financing expensive modern warfare.
   • Increase in Money Origin: Public debts encourage industrial production, boosting national income and living standards.
   • Suitable Repayment Balance: Facilitates a favorable business and repayment environment.
   • Non-economic Benefits: Strengthens international relations between debtor and creditor countries.
   • Secure Investment: Public debt offers a secure investment, attracting individuals.
   • Public Works: Finances projects like roads, electricity, canals, and bridges.
2. Disadvantages of Public Debt
   • Burden on Public: When debts fund non-productive works, tax burdens increase on the public for repayment.
   • Misuse of Resources of Country: Conditions must be set for using public debts, ensuring partial control over industries to prevent resource misuse, as significant amounts may go to foreign countries as interest.
   • Nature of Extravagance: Easy access to public debt may lead to extravagance.
   • Emergency: Public debt raises fears of emergencies like political controversies and wars.
   • Fear of Government’s Bankruptcy: Easy debt access may lead to unmanageable debt levels.
   • Political Burden: Debt-giving countries may influence the debtor country’s policies, leading to a loss of political freedom.
   • Economic Backwardness: Foreign debt weakens the economy, increasing dependence on other countries for development.

 

Way Forward

• Policy Shift: Shift fiscal policy focus from infrastructure to household support and green investment.
• Structural Reforms: Enhance the macro-fiscal framework and intergovernmental coordination with digital technology to support vulnerable groups.
• Multilateral Loans: According to Manmohan Singh, India could now “borrow from a position of strength” from institutions like the IMF and WB.
• Boost Economy: Implement a medium-term fiscal consolidation plan to boost market confidence and support structural reforms for growth.

India’s public debt ratio has been stable at about 70% of GDP since 1991. However, recent challenges have impacted debt and deficit targets, requiring more prudent fiscal management.

 

INDIAN FOREX RESERVES

According to the Reserve Bank of India (RBI), India’s forex reserves have fallen by USD 110 billion over the past 13 months.

Data Current: $531.1 billion (Oct 2022) India’s forex reserves dropped by USD 110 billion since September 2021, when they were at a record high of USD 642.45 billion. Net Remittances: Between 2009-10 and 2020-21, India received an estimated $450 billion in remittances from non-residents. FDI: India received $468.88 billion in FDI between 2009-10 and 2020-21. Others: Nearly 60% of reserves were accumulated after the 2008-09 global financial crisis, reaching around $250 billion at that time.

Reasons for Rise

• Foreign Investors: Increased net buying of Indian equities by foreign portfolio investors.
• Remittances: India has been the top recipient of remittances from overseas workers. From 2009-10 to 2020-21, India received an estimated $450 billion in net remittances from non-residents.
• Export Earnings: Balance of Payments shows net export earnings rose to $90.80 billion in 2020-21, up from $85.90 billion the previous year, driven by increased IT spending globally.
• Massive Liquidity Injection: Stimulus measures in the USA to counter Covid-19 impacts.
• Reduced Capital Outflow: Decreased foreign travel and consumption under Covid-19.
• Pandemic Trade Curbs: Narrower trade balance led to a lower drawdown of forex reserves in 2020-21 during global trade contraction.

 

Purpose of Forex Reserves

• Shock Absorber: Maintains liquidity to absorb shocks in crises or limited borrowing access.
• Purchasing Power: Ensures no balance of payments issues in global trade.
• Investor Sentiment: High forex reserves attract potential investors to the Indian economy.
• Exchange Rate: Manages the national exchange rate.
• Government Support: Helps fulfill external loan obligations during need.

 

Benefits of Having High Forex Reserves

• Balance of Payments: Helps meet international finance obligations, including debts and import financing.
• External Shocks: Acts as a cushion for unforeseen shocks; helped India withstand the 2008 global meltdown.
• Liquidity Against Risks: Supports overcoming domestic financial crises, like high NPAs and corporate bond issues.
• Attract FDI: Boosts foreign investor confidence.
• Exchange Rate Management: RBI uses reserves to stabilize the Rupee by selling Dollars.
• Foreign Policy Goals: Expands India’s ability to set up currency swap lines, like with SAARC nations.

 

Issues Associated

• Low Returns: Forex reserves yield low returns, usually around 1% or less due to low interest rates in advanced economies.
• High Opportunity Costs: High forex levels do not generate significant interest.
• Poor Confidence: High reserves may signal economic insecurity.
• Government Use: Governments sometimes use reserves to buy shares in public companies, which carries risk due to stock volatility.

 

Conclusion 

The Central Bank must balance maintaining buffer stocks for shock events with managing the opportunity costs of holding high forex reserves.

FOREIGN CURRENCY BORROWINGS

ECBs (External Commercial Borrowings) are commercial loans that eligible resident entities in India can raise from outside India, i.e., from a recognized non-resident entity.

Current Incidences

• Relaxed norms: The Reserve Bank of India (RBI) has relaxed norms for companies raising external commercial borrowings (ECBs) as part of a set of measures to curb the rupee’s slide.
• Hedging of borrowing: A significant portion of India’s ECBs are effectively hedged, according to RBI.
• Sovereign bond: The government, with RBI’s assistance, will finalize plans for issuing sovereign bonds overseas.
• Increase of borrowing limit: RBI previously raised the automatic borrowing limit from $750 million to $1.5 billion per financial year, valid until December 31, 2022.

 

Advantages

1. Low debt ratio: India’s sovereign external debt to GDP ratio, at 5%, is among the lowest globally, allowing the government to raise funds without significant negative effects.
2. Diversification of Investor Base: Eases pressure on domestic bond rates by diversifying funding sources.
3. Solves Issue of Crowding Out: Overseas borrowing frees up domestic credit for the private sector.
   • Example: A fiscal deficit relaxation to 4.4% could allow an additional ₹2 lakh crore borrowing from the domestic market.
4. Less Expensive: Foreign currency borrowings are generally less costly due to lower overseas yields.
   • Example: Indian firms could benefit from lower interest rates in economies like the US and Europe.
5. Financial Discipline: Allows the government to reduce the fiscal deficit gradually.
6. Easy funds available globally: Lower interest rates in advanced economies, coupled with foreign monetary policies, mean there are surplus funds ready for investment.
7. Long maturity: ECB funds are often available for relatively long terms.
8. Reduce deficit: ECB programs enable the government to maintain fiscal deficit reduction.
9. Demand for government securities: Overseas borrowing may positively affect domestic demand for government securities.
10. Economic Growth: The government can direct ECB inflows to sectors like SMEs, boosting the economy.
    • Example: A higher percentage of ECB funding for SMEs can contribute to national growth.

 

Risks

• May Hurt Exports: Increased foreign reserves could strengthen the rupee, potentially discouraging exports.

• Currency Risk: If the loan is in dollars, and the rupee weakens against the dollar during the bond’s tenure, the government would need to pay more rupees to cover the same dollar amount.
• Global Vulnerabilities: Borrowing from international markets increases exposure to global financial risks.
• Costlier Deal: India’s exchange rate is more volatile than the yields on its G-secs (government securities), meaning that while borrowing may initially seem cheaper, rupee depreciation could make it costlier.
• Pressure on Domestic Market: External borrowing may not significantly reduce the need for domestic market absorption of government bonds.
• Uncontrolled Borrowing: Access to cheap and plentiful funds should not lead to excessive government borrowing.
• Bad Image: Relying on sovereign bonds may signal that the government is running out of domestic borrowing sources.
• Less Control over Inflation: Overseas bonds could limit the government’s ability to manage inflation effectively.
• International Experience: Concerns arise that India might follow Mexico and Brazil’s paths, where heavy overseas borrowing led to unsustainable debt as currencies depreciated sharply.

 

Way Forward

1. Generate Enough Revenue: The government should aim to increase revenue to reduce the need for borrowing.
2. Strengthen Tax Discipline: Expanding the tax base and instilling discipline could improve revenue and limit the need for external borrowing.
3. Suggestions:
   • Measured Approach: Adopting a balanced approach and maintaining fiscal discipline in foreign borrowing.
   • Fiscal Prudence: Follow fiscal discipline as outlined in the FRBM Act to reduce rupee pressure after foreign borrowing.
   • Capital Expenditure: Channel foreign borrowing into capital projects to create government income sources and boost economic activity.
   • Proactive Central Bank: The RBI should remain vigilant about foreign borrowing and guide the government during economic downturns.

India should be cautious, as excessive foreign borrowing could become a double-edged sword, tempting the government to repeatedly return to foreign markets for funds, potentially compromising India’s credibility. It’s essential to rely on domestic borrowing in most cases.

NATIONAL MONETISATION PIPELINE

Recently, the Union Finance Minister unveiled the Centre’s four-year infrastructure asset monetization program to raise ₹6 trillion under the National Monetization Pipeline (NMP) project. The monetization plan was first announced in the annual budget speech in February 2021. It will serve as a medium-term roadmap for the government’s asset sale initiative.

About National Monetisation Pipeline

• Four-year plan: The NMP comprises a four-year pipeline of the Central Government’s brownfield infrastructure assets.
• Medium-term roadmap: It serves as a roadmap for the Asset Monetization initiative, providing visibility for investors.
• Budget emphasis: The 2021-22 Union Budget highlighted Asset Monetization to raise innovative and alternative financing for infrastructure.
• Government view: The government sees asset monetization as a strategy for infrastructure augmentation and maintenance, not just a funding mechanism.
• Aim: Unlock the value of investment in public assets that have not yielded appropriate returns so far.

 

Objectives of the Program

• High-quality infrastructure: NMP aims to provide universal access to high-quality, affordable infrastructure for India’s citizens.
• Tapping private sector investment: Asset monetization aims to attract private sector investment for new infrastructure creation.
• Job creation: Necessary for employment opportunities, integrating rural and semi-urban areas for public welfare.
• Strategic objective: Unlock investment value in brownfield public sector assets by attracting institutional and long-term patient capital.

Roadmap of NMP 

The framework for core asset monetization has three key imperatives:

• Monetisation of rights, not ownership: Assets are handed back at the transaction’s end, with transactions structured around revenue rights.
• Brownfield de-risked assets: Focus on brownfield projects where investments have been made, targeting under-utilized or unmonetized assets.
• Structured partnerships: Under competitive bidding and defined frameworks, partners must adhere to Key Performance Indicators and Performance Standards.

Significance of NMP

1. Economic

• Easing fiscal burden: Frees balance sheets for greenfield infrastructure creation.
  • Example: A government-built stadium could be leased to a private party for cultural functions, generating revenue.
• Provide additional resources: Helps states sustain public investment amid financial constraints.

• Mobilising Private Capital: Since the assets are de-risked as brownfield projects, it will help in mobilising both domestic and foreign private capital. Global investors are keen to participate through transparent and competitive bidding.
• Overcoming COVID slowdown: Government-led capital creation has been crucial globally to counter the economic slowdown induced by COVID-19.
• Recovery of investment: Investments in core assets leased out can be recovered quickly.
  • Example: Leasing a highway for 30 years transfers operational responsibilities, including toll collection, to the private entity, which pays a lump sum upfront, allowing the government to recover its investment quickly.
• Profitability in projects: The government is monetizing underperforming assets. Private players will work to make these assets profitable to earn returns.
• New avenue for investment: This model allows financial and strategic investors, as well as the general public, to invest in asset classes, creating new investment avenues.
• Employment generation: Returns for PSUs from asset monetization, along with private sector bidding, will increase productivity and generate employment.

2. Institutional

• Rationalization of Process: Asset monetisation, though not new, is now organized into structured baskets with targets, identified challenges, and a defined framework.
• Public-Private excellence for common good: The collaboration enables ‘Infrastructure Creation through Monetisation,’ where public and private sectors leverage their core strengths for socio-economic growth.

3. Infrastructure

• Paradigm shift in operations: Asset monetisation should be seen as a paradigm shift, not just a funding method, with augmentation and maintenance benefits from the private sector’s efficiency and adaptability.
• Financing infrastructure creation: Due to a large infrastructure deficit, the government aims to lease existing assets to private firms under revenue-sharing models to raise funds.
• Spillover effect: Infrastructure investment has a high demand cycle impact, supporting further infrastructure investment.

4. Political

• Less political resistance: Leasing to the private sector without transferring ownership is expected to face less opposition resistance.

 

Associated Challenges

1. For Investors

• Investor issues: There may be a lack of interest among investors in lower-value sectors, like highways below four lanes.
  • Example: Slow privatization in entities like Air India and BPCL, along with lower interest in PPP initiatives, shows challenges in attracting private investment.

• Return on asset: Currently, many core assets to be leased do not yield enough returns due to systemic hurdles. Without addressing these issues, private involvement may not improve returns significantly.
• Land Monetization problem: A key challenge is unified mapping of land under various ministries and CPSEs (Central Public Sector Enterprises).
  • Example: DIPAM is reviewing global examples of land banks to decide on the sale strategy.
• No guarantee of profit: There is no certainty that private players will make assets profitable, as seen in several bankrupt private companies.

2. For Government

• Utilization of Funds: Clarity on fund utilization is essential. Funds should not support short-term budgetary needs and must adhere to company law.
• Creation of a regulatory framework: Regulatory frameworks are needed to handle monopolies, especially for projects like railways under the NMP.
• Structural challenges: Maintenance of asset registers, title issues, land unavailability, delayed approvals, and lack of stakeholder coordination could obstruct progress.
• Long-term headache: Concession periods, sometimes extending up to 60 years, could create long-term issues if not balanced between profit and public utility.
• Identification Problem: Separating operating sections of assets from non-operating ones can be challenging.
  • Example: Determining how to categorize parts of the freight corridor.
• Problem for next government: Leasing assets to private players means revenue may be preempted, creating budgetary challenges for future administrations.

3. For Public

• Cost issue: Core infrastructure assets also serve public welfare. If private operators increase costs, the public may bear the burden unless regulated.
• Job losses: Privatization may lead to layoffs, as private firms prioritize efficiency.

4. Other

• Resistance: Ideological resistance is likely, with accusations of “selling the family silver.” Illegal occupation of unutilized government land may also complicate matters.

• Broader plan: The government plans to use the InvITs and REITs route to monetize public assets like highways, gas pipelines, railway tracks, and power transmission lines.

 

NITI Aayog recommendation for NMP

1. Aayog recommendation: Recently, the NITI Aayog has recommended bringing in policy and regulatory changes to scale up monetisation instruments like Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (REITs) as a critical element for success of the NMP.
2. Major recommendations

• Expansion of base and scale: Expanding the investor base and monetization instruments like Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (REITs) is seen as a “key imperative.”
• Tax efficient mechanism: Implementing tax-efficient, user-friendly mechanisms to attract investors.
• Tax breaks: Granting capital gains tax relief for those investing in InvITs to appeal to retail investors.
• InvITs under IBC: Including InvITs under the Insolvency and Bankruptcy Code, providing an insolvency option for added investor comfort.

 

Way Forward

• Commission for identification: Forming a commission to identify assets for monetization, define the modus operandi, and allocate funds.
• Preventing a monopoly: Ensuring no single firm captures the majority of assets.
• Structuring the deals: Success lies in structuring deals to attract sufficient private-sector participation.
• Smooth implementation: Implementing the first few projects correctly is vital for momentum. Meeting the first-year target of Rs 0.8 trillion will build market confidence.
• Proper regulation: To maximize profit, investors may increase prices or reduce maintenance, so strong regulatory mechanisms are necessary.
• Transparent process: The government should maintain transparency, adhere to timelines, and engage the public.
• Use of idle resources: Defence and railways hold substantial land that could be leased. Any private expenditure on such land could be offset against upfront leasing fees to the government.
• Quality benchmark: Setting clear quality benchmarks for assets handed over to private parties, including Key Performance Indicators for operation and maintenance.

Conclusion 

Monetization of assets is not new, but the government has finally organized it with defined baskets, targets, and frameworks. Unlocking assets worth Rs 6 lakh crore is ambitious, but addressing these impediments should attract investors. The monetization process involves stakeholder management, coordination, and thorough due diligence of technical, operational, and financial aspects.

 

ASSET MONETIZATION

Asset Monetization, commonly referred to as asset or capital recycling, involves the creation of new sources of revenue by unlocking the value of hitherto unutilized or underutilized public assets.

Data Target for FY22: The central government has exceeded its asset monetization target of ₹88,000 crore for FY22 and has completed deals worth ₹96,000 crore as of April 2022. Target for FY23: For FY23, the Centre has firmed up an asset monetization target of over ₹1.6 trillion. Sectors: Roads, railways, and power sector assets will comprise over 66% of the total estimated value of the assets to be monetized.

 

Framework of Asset Monetization

• The framework for monetization of core assets has three key imperatives:
  • Monetization of ‘Rights’ NOT ‘Ownership’: Assets are handed back at the end of the transaction life.
  • Brownfield de-risked assets: Stable revenue streams.
  • Structured partnerships: Defined contractual frameworks with strict KPIs & performance standards.
• Instruments identified under NMP: These include direct contractual instruments such as public-private partnership concessions and capital market instruments like Infrastructure Investment Trusts (InvITs) among others.

 

Structure of Asset Monetization

Asset Monetisation, as envisaged by National Monetization Pipeline, entails a limited period license/lease of an asset, owned by the government or a public authority, to a private sector entity for an upfront or periodic consideration.

 

Benefits of Asset Monetization

1. For the government

• Unlock value of investments made: The objective of the asset monetization programme of the Government, is to unlock the value of investment made in public assets which have not yielded appropriate or potential returns so far.
  • For example: The Centre is pursuing creation of ₹111 trillion worth of greenfield infrastructure projects for which it needs to generate resources.

• Source of income: Asset monetization will help in creation of unexplored sources of income for the company and its shareholders.
• Better management of resources: It will contribute to a more accurate estimation of public assets, which would help in better financial management of government/public resources over time.
• Freeing of resources: It helps public sector authorities/entities in easing fiscal constraints and freeing up the balance sheets for taking up more greenfield infrastructure creation or spending in social sector and other competing public priorities.
• Tapping of capital: The strategic objective of the programme is to unlock the value of investments in brownfield public sector assets by tapping institutional and long-term patient capital, which can thereafter be leveraged for further public investments.

2. For private sector

• De-risked from variables: The government has stressed that these are brownfield assets, which have been “de-risked” from execution risks, and therefore will encourage private investment.
• Participation in nation-building: By identifying assets across 13 core sectors, the government has paved the way for active private sector participation across all the major sectors, thus creating an enabling environment for private sector to participate in nation-building.

                            

3. For society and economy

• Investments in infrastructure sector: Private debt to GDP ratio in India is at around 56%, which is lower than in many other countries. Asset sale programme will facilitate more debt and equity investments into the infrastructure sector.
• Paradigm shift in infrastructure sector: Asset Monetization will bring an overall paradigm shift in infrastructure operations, augmentation and maintenance considering private sector’s resource efficiencies and its ability to dynamically adapt to the evolving global and economic reality.
• Economic efficiency: Asset monetisation was not just about garnering revenues for the government but also ensuring the economic efficiency of these assets by bringing them back to productive use.
• Employment generation: Asset monetization is necessary for creating employment opportunities, thereby enabling high economic growth.

• Stakeholder Complexity: Cases like Konkan Railway, with multiple state stakeholders, present challenges in creating effective monetization structures.

• Contract Enforcement: Long-term infrastructure contracts require robust dispute resolution and enforcement mechanisms.
• Lack of Trust: Public authorities face reluctance to address bidders’ commercial concerns due to fears of accusations of collusion.
• Sector-Specific Challenges: Issues like capacity utilization in gas and petroleum pipeline networks and regulated tariffs in power sectors.

4. Other Monetization Challenges:

• Privatization vs. Monetization: Privatization removes government from business operations, while monetization keeps the government as an active player.
• Monopolistic Concerns: High asset costs may result in a few business houses controlling significant portions.
• State Participation: Lack of involvement from state governments can disrupt the monetization plan.
• Regulatory Clarity: The need for consistency, clarity, and stability in regulatory frameworks is critical for investor confidence.

 

Government initiatives:

• Asset Monetization Plan: It was announced in Union budget for FY22 as an important financing option for creating new infrastructure assets. The plan entailed a pipeline of ₹6 trillion worth of assets to be monetised in a four-year period till FY25.
• National Monetization Pipeline (NMP): The pipeline has been developed by NITI Aayog, based on the mandate for ‘Asset Monetisation’ under Union Budget 2021-22. NMP estimates aggregate monetisation potential of ₹6.0 lakh crores through core assets of the Central Government, over a four-year period, from FY 2022 to FY 2025.
• Asset Monetisation dashboard for tracking progress and for providing visibility to investors.

 

Asset Monetization: Successful instances

• NHAI has monetized close to 1,400 km of toll roads through TOT concessions and has raised Rs. 17,000 crore.
• PowerGrid successfully launched the first ever public sector InvIT monetizing its first batch of transmission assets and raising Rs. 7,700 crore.
• Airports Authority of India successfully monetized 6 brownfield AAI airports through OMDA model raising upfront proceeds and private investment towards augmentation of the airports.
• Indian Railways also launched the strategic foray into PPP in station redevelopment and running of passenger trains.

 

Way Forward

1. Legal and Operational measure
   • Amendment of contractual terms: A principle-based framework for review or amendment of contracts to arrive at the right solution makes business, financing and operation and maintenance easier. ○ For example: Periodic review or provision for mandatory contract revision as has recently been introduced in Brazil and it engenders flexibility in PPP contract.
   • Establishing independent regulatory bodies operating under a set of well-defined parameters can prove invaluable to successful PPPs, be it for tariff or standard setting, or dispute resolution.
   • Sustainable and socially sensitive: Infrastructure development and monetisation must be sustainable and socially sensitive basis, given that we are trustees of such infrastructure for future generations.
   • Special Legal Framework: Many developing countries have a special legal framework governing PPPs, to amend the role of the state on conflict and contractual principles and smoothen friction seen previous PPPs.
   • Redressal system: The Government will have to create a robust redress system, independent regulation, and ensure renegotiation of concession agreements to enable a solid operational trajectory for the scheme’s execution.
   • Better auction process: For instance, directives by the European Commission stipulate customised auction process by public authorities for the project at hand.
2. Other measures 
   • Policy stability, consistency and transparency would have to spill over into the regulatory framework that would govern asset monetisation moving forward and that is what would make a very big difference between a success and a not so successful programme. 
   • Attractiveness of asset: Private sector response will depend on the attractiveness of specific assets. Thus, the requirement of a detailed outreach program, followed by due diligence on each asset, will be imperative. This will help to arrive at the optimal valuation and adoption of most suited private participation model. 
   • Collaboration: It is quite imperative to work with sector experts and industry professionals to reach out to the global players to ensure time-bound and result oriented processes. 
   • State cooperation: States can help by putting forth their assets, including power generating plants, transmission networks, warehousing facilities and expressways, so that the Center can incentivize the monetization of these assets.

 

STATE FINANCES

The RBI’s publication on state budgets for 2021-22 indicates concerns over high state debt-to-GDP ratios. Recently, the central government released ₹1.16 lakh crore in tax devolution to help states accelerate their development efforts.

This section emphasizes contract flexibility, regulatory bodies, sustainability, transparency, and collaboration for successful asset monetization. It also notes government support to states for fiscal stability and development.

Current incidents Recently, the Centre released two instalments of tax devolution totalling Rs 1.16 lakh crore to states. This is in line with the commitment of the government to strengthen the hands of states to accelerate their capital and developmental expenditure. High debt burden: According to a recent RBI study, 10 states have a significantly high debt burden. These include Punjab, Rajasthan, Kerala, West Bengal, Bihar, Andhra Pradesh, Jharkhand, Madhya Pradesh, Uttar Pradesh and Haryana. These 10 states account for around half of the total expenditure by all State governments in India. Exceed commitment: Among the 10 states, Andhra Pradesh, Bihar, Rajasthan and Punjab exceeded both debt and fiscal deficit targets for 2020-21 set by the 15th Finance Commission. State projections: Further, Punjab’s debt-GSDP ratio is projected to exceed 45% in 2026-27. Rajasthan, Kerala and West Bengal are projected to exceed the debt-GSDP ratio of 35% by 2026-27. Cumulative debt of States: The cumulative debt of States has risen from 19.1% in 2018-19 to 25.1% in 2021-22.

Sources of state revenue

• Vertical devolution (States’ share of taxes): As states share of taxes from the gross tax revenue is given, this is extra-budgetary. As per the 15th Finance Commission Recommendations, 41% of the divisible pool should be devolved to the States.
• Horizontal devolution: Formula recommended the Finance Commission considers different parameters like Income Distance, Population of 2011, Area, Forest & Ecology, Demographic Performance and Tax Effort.

• Scheme Related Transfer: This is part of the Union Budget and is given as Centrally Sponsored Schemes from the Scheme Expenditure.
• Finance Commission Grants: Based on Finance Commission recommendations, the Center also gives states – (a) Revenue Deficit Grants (b) Sectoral Grants, and (c) Performance-based Incentives. The Finance Commission Grants will be mentioned in the Union Budget.
• Other Transfers: Other grants or loans given to states as mentioned in the Union Budget.

 

Importance of state finances

1. Economic

• Macroeconomic stability: If states find it difficult to raise revenues, it would lend more resulting in them paying more towards interest payments instead of education, health, etc.
• Capital spending: About two-thirds of India’s public capex comes from states, the highest decentralization of capital spending globally.
• Overall economic health: High market borrowings by states has serious implications on the interest rates charged in the economy, the availability of funds for businesses to invest in new factories, and the ability of the private sector to employ new labour.
• Impact on national economy: When the combined expenditure of both the centre and states contracts from one year to the other, it will bring down India’s GDP.
• Investment: States having good financial credentials are more likely to attract investment than those with poor ratings.

2. Social

• Social Welfare: Welfare schemes are directly dependent upon state expenditure, lack of finances compromises state’s ability and thus the welfare.
• Infrastructure: Key development infrastructures like medical centres, housing and schools will be affected.
• Crime: Low social spending may lead to rise in criminal activities like theft and robbery etc.

3. Governance

• Stability: Good Financial position enable a better governance structure.
• Policy implementation: Government can honour its election promises and policies.

 

Status of state finances in India

1. Pandemic related

• Impact of Covid-19: The scissor effect of the Covid-19 pandemic — collapse in revenue and rise in health-related costs — will have a significant impact on state government finances.
• Fiscal deficit doubled: Average value of gross fiscal deficit to GSDP for the states before the pandemic is 2.4%, while the same made post-outbreak budget presentations is 4.6%.
• Lower capital spending: It is a result of states not being able to start a lot of projects due to the lockdown in the first quarter and monsoon in the second quarter.
• Delay in GST collection: The delay has complicated their fiscal position and cash flow management.
• Reverse migration: States had to deal with a massive wave of reverse migration during the pandemic, a different kind of push/pull factor worked during the pandemic, associated with high levels of informal unemployment.

2. Economic [Reasons of higher debt]

• Tax buoyancy (ratio of change in taxes and GSDP): Higher tax buoyancy implies that tax collection would rise at a faster pace for the same rise in incomes. The implied tax buoyancy for 2020-21 is higher than budgeted on the basis of 2019-20 revised estimates.
• States Goods and Service Tax (SGST): SGST collections fell by 47.2% during the first quarter of 2020-21 quarter. State receipts will also suffer because of a fall in the divisible pool of the Centre’s tax revenue.
• Impact on borrowing costs: The resultant slippage in fiscal deficit target could probably reflect in higher borrowing requirements for the next fiscal.
• Higher combined debt-to-GDP ratio: The combined debt-to-GDP ratio of states is expected to remain at 31% by end-March 2022 which is worryingly higher than the target of 20%.
• Low property tax collection: Property tax collection level in India is significantly lower (0.2% of GDP) as compared to some of the developed countries due to factors like undervaluation of property, incomplete property tax records, and inefficient administration.
• High Revenue Expenditure: The share of revenue expenditure in total expenditure of these states varies in the range of 80-90%. This results in poor expenditure quality, as reflected in the high revenue spending to capital outlay ratios.

• Significant Committed Expenditure: Like interest payments (on debt), pensions and administrative expenses accounts for a significant portion (over 35%) of the total revenue expenditure in some of these states.
  • For example: For some states, the interest payments exceed 20% of the Revenue Receipts of the Government like Haryana (23%), Punjab (21%), Tamil Nadu (21%). This constraints State finances.
• High DISCOMS Losses: The combined losses of DISCOMS in the five most indebted states, viz Bihar, Kerala, Punjab, Rajasthan and West Bengal, constituted 24.7% of the total DISCOMs losses in 2019-20. While their combined long-term debt was 22.9% of the total DISCOM debt in 2019-20.
• Freebie Culture: Political parties are outdoing each other promising free electricity and water, laptops, cycles etc. The freebies put a significant strain on the fiscal position of State governments and can’t be easily taken back by succeeding governments.
• Legal Loopholes: The current FRBM provisions mandate that the Governments disclose their contingent liabilities, but that disclosure is restricted to liabilities for which they have extended an explicit guarantee.
  • For example: In reality, the State governments resort to extra-budgetary borrowings to finance their populist measures. This debt is concealed to circumvent the FRBM targets. Further, there is no comprehensive information in the public domain to assess the size of this off-budget debt.

 

Challenges of state finances in India

1. Economic

• Low revenue generation: The economic slowdown had created a challenging fiscal environment for the states.
• Low devolution by 15th FC: The share of states in the centre’s taxes is recommended to be decreased from 42% during the 2015-20 period to 41% for 2020-21.
• Effect of DISCOM debt burden: With continuing losses of power distribution companies and rising guarantees, poses a risk to state finances.
• Lack of sources to raise capital: States are not empowered to float bonds or borrow freely from outside sources, hampering their fiscal position.
• Growing cesses and surcharges reduce tax devolution to states: While the cess and surcharge revenue remained around 10-15% of Gross Tax Revenue during 2011-20, its share is estimated to significantly increase to 24% in 2020-21.

2. Social

• Rising inflation rates: To partially offset the revenue shortfall, states hiked their duties on petrol, diesel and to make room for higher expenditure on healthcare and social services.
• Infrastructure: Projects that require high levels of state investment will suffer and undergo delays and stalling.

3. Political

• GST implementation: Some State revenues have fallen since GST, as states have lost taxation powers.
• Populism: Fiscal policy is often used to satisfy electoral needs like loan waivers etc.

 

Government intervention

• Special Assistance to States for Capital Expenditure for 2021-22: Under the scheme, states will be provided interest-free loans of up to Rs 15,000 crore in 2021-22, that need to be repaid after 50 years.

• Reform-linked additional borrowing space for 2020-21: In view of the COVID-19 pandemic, the central government permitted states to increase their fiscal deficit limit from 3% of GSDP to 5% in 2020-21.

 

Way Forward

1. Administrative
   • Rationalise the expenditure: RBI has thus suggested reducing leakages and enhancing efficiency of the public distribution system along with improving public financial management practices to rebuild the fiscal space.
   • Institutional reforms: The municipal bond market should be a major focus for future financial sector reform.
   • Reporting of liabilities: States should amend their fiscal responsibility legislation to ensure consistency with the Centre’s legislation, in particular, with the definition of debt.
2. Economic
   • State-issued grants: Transfers from the upper tiers of government should be quicker and easier to access.
   • Sin Tax: Levying heavy taxes on sin items like alcohol, cigarettes, and pan masala etc. to achieve dual target of stopping people to harm their health and increase revenue.
   • Debt management agencies: Although unconventional, it can be set up to restructure the government debt.
   • Expand tax base: States need to gradually harness the GST database to expand the tax base.
   • Case of no GST compensation: With decreasing revenue even for Centre, it seems states will have to start gearing up for life without the GST compensation.
3. Structural
   • Independent fiscal council: As recommended by 15th FC, an independent Fiscal Council should be established with powers to assess records from the Centre as well as states.
   • Strengthen third-tier governments: RBI report has made recommendations like increasing the functional autonomy of the civic bodies, strengthening their governance structure and empowering them financially through own resource generation and transfers.
   • Reforms in the power sector: In the medium term, improvements in the fiscal position of state governments will hinge upon the reforms in the power sector as recommended by FC-XV.
     • Improving the health of the power DISCOMs by alleviating their liquidity stress
     • Creating transparent and hassle-free provision of power subsidy to farmers
     • Timely payments of state dues to DISCOMS
4. RBI recommendations
   • In the near term, State governments must restrict their revenue expenses by cutting down expenditure on non-merit goods.
   • In the medium term, States need to put efforts towards stabilizing debt levels.
   • In the longer term, States need to increase the share of capital outlays in the total expenditure. This will help create long-term assets, generate revenue and boost operational efficiency.

The figure and the trends indicated the financial risk the states are staring at. Centre must initiate the measure to revive the economy in order to address the problems faced by the states and ensure that the states are not left in lurch while SGT compensation receipts get delayed. States need to combine efforts towards mobilising higher revenues with strategies to maximise efficiency gains rather than mere increase in tax rates.

 

INVESTMENT MODELS

Investment models determine the specific modes in which funds are invested in various assets to generate income. Investing is essential for economic growth and development, impacting sectors like business, agriculture, manufacturing, and supporting industries. A strong investment environment encourages government and private sector collaboration, thereby creating job opportunities and fostering economic growth.

Investment Models Used in India

1. Harrod-Domar Model: A one-sector model where economic growth is reliant on policies that boost savings and technological advancements.
2. Solow Swan Model: Builds on the Harrod-Domar Model, emphasizing productivity growth.
3. Feldman-Mahalanobis Model: Focuses on domestic consumption goods with high capital capacity, evolving into the four-sector Nehru-Mahalanobis model, primarily targeting capital goods.
4. Rao Man Mohan Model: Named after Narasimha Rao and Dr. Manmohan Singh, this model represents economic liberalization, particularly with the introduction of FDI in 1999.

 

Factors Affecting Investment Sentiments

Several factors influence investment sentiments, including:

• Savings Rate: Higher savings can provide more funds for investment.
• Tax Rate (Net Income Available After Tax): Impacts disposable income and potential returns.
• Inflation: Affects purchasing power and investment stability.
• Interest Rates in Banks: Higher interest rates can attract deposits but may deter borrowing for investment.
• Possible Rate of Return on Capital: Higher returns encourage investment.
• Availability of Other Production Factors: Such as affordable land and labor.
• Supporting Infrastructure: Transport, energy, and communication are essential for a conducive investment environment.
• Market Size and Stability: A larger, stable market attracts investment.
• Investment-Friendly Policies: Government policies that support investment.

 

Types of Investment Models

1. Public Investment Model: Investment in specific goods and services are made by the government with the help of the public sector by using the revenue earned through it.

• Improve productivity: By enhancing public-sector investment large pools of savings can be channelized into productivity.
• Boost to economy: Properly targeted public investment can do much to boost economic performance, generating aggregate demand quickly, fuelling productivity growth by improving human capital, encouraging technological innovation, and spurring private-sector investment by increasing returns.
• Accelerate recovery: Though public investment cannot fix a large demand shortfall overnight, it can accelerate the recovery and establish more sustainable growth patterns.

1. Private Investment Model: When the earnings from the public sector is not enough to make up for certain shortfalls that may come about, the government invites private players to invest in some of its ventures.
   • Source: Private investment can be source from domestic or international market.
   • Efficient: Private investment can generate more efficiency by creating more competition, realization of economies of scale and greater flexibility than is available to the public sector.
   • Foreign investment: From abroad private investment comes in the form of FDI or FPI.

Foreign Portfolio Investment (FPI)	Foreign Direct Investment (FDI)
Investment made in the financial assets of an enterprise, based in one country, by the foreign investors	International investment in which the investor obtains a lasting interest in an enterprise in another country
An investor is inactive	An investor is active
Indirect investments in assets are made	Direct investments in assets are made
Investments made are short term in nature	Investments made are long term in nature
FPI are volatile in nature	FDI are stable in nature

 

1. Public Private Partnership Model: A public-private partnership (PPP, 3P, or P3) is a cooperative arrangement between two or more public and private sectors, typically of a long-term nature.
   • Time bound: In this type of partnership, investments are undertaken by the private sector entity, for a specified period of time.
   • Efficient: These partnerships work well when private sector technology and innovation combine with public sector incentives to complete work on time and within budget.
   • Government control: As PPP involves full retention of responsibility by the government for providing the services, it doesn’t amount to privatization.
   • Risk sharing: There is a well-defined allocation of risk between the private sector and the public entity.
   • Competitive: Private entity is chosen on the basis of open competitive bidding and receives performance linked payments.
   • Expertise: It can also give required private expertise in planning or executing large projects.
   • Saves government from money crunch: PPP route can be alternative in developing countries where governments face various constraints on borrowing money for important projects.

 

Models of Public Private Partnership (PPP)

Schemes	Modalities
Build-own-operate (BOO)	Private sector designs, builds, owns, develops, operates and manages asset with no obligation to transfer ownership to government.
Build-develop-operate (BDO)	Private sector designs, builds, owns, develops, operates and manages asset with no obligation to transfer ownership to government.
Design-construct-manage-finance (DCMF)	These are variants of design-build-finance-operate (DBFO) schemes.
Buy-build-operate (BBO)	The private sector buys or leases an existing asset from the Government, renovates, modernises, and/or expands it, and then operates the asset, again with no obligation to transfer ownership back to the Government.
Lease-develop-operate (LDO)	The private sector buys or leases an existing asset from the Government, renovates, modernises, and/or expands it, and then operates the asset, again with no obligation to transfer ownership back to the Government.
Wrap-around addition (WAA)	The private sector buys or leases an existing asset from the Government, renovates, modernises, and/or expands it, and then operates the asset, again with no obligation to transfer ownership back to the Government.
Build-operate-transfer (BOT)	The private sector designs and builds an asset, operates it, and then transfers it to the Government when the operating contract ends, or at some other pre-specified time.
Build-own-operate-transfer (BOOT)	The private sector designs and builds an asset, operates it, and then transfers it to the Government when the operating contract ends, or at some other pre-specified time.
Build-rent-own-transfer (BROT)	The private sector designs and builds an asset, operates it, and then transfers it to the Government when the operating contract ends, or at some other pre-specified time.
Build-lease-operate-transfer (BLOT)	The private partner may subsequently rent or lease the asset from the Government.
Build-transfer-operate (BTO)	The private partner may subsequently rent or lease the asset from the Government.

 

Other common PPP models

1. Engineering – Procurement – Construction (EPC) model: Private entity is designs, finances and builds the asset. After building the asset, it is transferred to the public entity which remains the owner. The private entity does not have the responsibility of operations and management and receives a lump-sum money from the public entity for its role.
   • Example: It is being used for the construction of highways by the NHAI.
2. Hybrid Annuity Model (HAM): It is a mix of EPC and BOT models where the public entity finances 40% of the project cost as the annuity and the private entity has to finance the remaining 60%. The ownership and operations will be the responsibility of the public entity while the private entity will provide the engineering expertise.
   • Example: This model is gaining prominence for highway construction in recent times.

 

Challenges associated with PPP projects

1. Administrative
   • Political uncertainty: Because of long payback period, they are expected to come under frequent political change. Attitude, will, ideology of government in power differs.
   • Land acquisition and Environment Clearances: As many as 189 projects with a cost of Rs 1,80,000 crore were stuck due to problems in land acquisition, delays in forest and environment clearances, non-transfer of defence land and hurdles in rail overbridges
   • Multiplicity of regulation: Because of public nature of the works, they come under supervision and scrutiny of multiple independent regulators, such as environmental, local development boards, labour, CAG etc which increases gestation period and compliance costs.
   • Flawed project assessments: Most of the recent PPP projects were undertaken in 2006-2010 when economy was performing well which influenced the investors because of their excessive optimism which is now costing them dear.
   • Frequent renegotiations: PPP firms use every opportunity for renegotiating contracts by citing reasons like lower revenue or rise in costs which resulted into drain of larger share of public resources. These firms create a moral hazard by their opportunistic behaviour.
   • Inefficient regulation: Indian government has a poor record in regulating PPPs in practice.
     • Example: Metro projects become sites of crony capitalism and a means for accumulating land by private companies.

1. Economic
   • Cost escalation: Last decade have seen unprecedented inflation, more particularly in construction sector. In absence of flexibility of pricing, investor have no option other that abandoning the project.
   • Long term: It is not possible to account for each and every exigency which may crop up in the future. So it is desirable to have flexibility in contracts.
   • Lack of exit options: Because of overall low capacity in the economy there are, no exit options for investors. Govt. recently decided to scrutinize investments to remedy this and to provide exit option at certain periods.
   • Pricing barriers: Public goods and services can’t be delivered on charging cost plus profit prices. Subsidized pricing is hallmark of these services.
   • Affecting banking sector: Loans for infrastructure projects are believed to comprise a large share of the non-performing asset portfolio of public sector banks in India.
   • Crony capitalism: In many sectors, PPP projects have turned into conduits of crony capitalism. Many PPP projects in infrastructure sector are run by “politically connected firms” which have used political connections to win contracts.
2. Social
   • Public activism: In many cases it is seen that, while projects are awarded on one hand, there is widespread public agitation on the other. Risk and costs of this should be undertaken by the govt.

 

Public-Private Partnerships (PPP) – Recent Developments

• Health Sector: NITI Aayog has come out with PPP Model to address the gap in medical education and the shortage of qualified doctors. As per this model, existing or new private medical colleges will be linked with functional district hospitals.
• Power Sector: Under Atal Distribution Transformation Yojana Scheme, if states will involve private sectors to improve the efficiency of state distribution companies (discoms), then the Central Government will provide incentives to the States.
• Railways: Tejas Express is the 1st private train in India. Under the PPP model, the services like housekeeping, catering, ticketing, etc. in the Tejas Express will be provided by private players while the physical infrastructure for the Tejas Express will be Indian Railways
• Urban Housing: Through PPP, Government-funded housing in cities or urban areas will be converted into Affordable Rental Housing Complexes (ARHC). This will be done so that migrants can avail housing at concessional rates in cities or urban areas.

 

Government Policies for PPP projects

1. Viability Gap Funding: It supports infrastructure projects that are economically justified but fall marginally short of financial viability. Support under this scheme is available only for infrastructure projects where private sector sponsors are selected through a process of competitive bidding. Funding can be provided by both central and state governments.
2. India Infrastructure Finance Company Ltd.: To provide long term finance to viable infrastructure projects through the Scheme for Financing Viable Infrastructure Projects through a Special Purpose Vehicle.
   • Eligible sectors for financial assistance: Transportation, energy, water, sanitation, communication, social and commercial infrastructure

1. Infrastructure Debt Funds (IDFs): They are investment vehicles to accelerate the flow of long term debt to the sector. IDFs aim at taking out a substantial share of the outstanding commercial bank loans.
2. India Infrastructure Project Development Fund (IIPDF): Scheme supports the Central and the State Governments and local bodies through financial support for project development activities (feasibility reports, project structuring etc) for PPP projects
3. Foreign Direct Investment (FDI): Up to 100% FDI in equity of SPVs in the PPP sector is allowed on the automatic route for most sectors.
4. 3P India: Created with a corpus of Rs 500 crore, it provides support for mainstreaming of PPPs. The planned 3P India entity will examine issues related to regulation, financing structure, management of contracts and stressed Public-Private Partnership projects.

 

Ways Forward

1. Vijay Kelkar Committee Report on Revisiting and Revitalising PPP Model
   • Improve existing PPP mechanism: Given the urgency of India’s demographic transition, and the experience India has already gathered in managing PPPs, the government must move the PPP model to the next level of maturity and sophistication.
   • Infrastructure PPP Adjudication Tribunal: To be chaired by a Judicial Member (former Judge SC/Chief Justice HC) with a Technical and/or a Financial member, where benches will be constituted by the Chairperson as per needs of the matter in question.
   • Rebidding and cancellation: Projects that have not achieved a prescribed percentage of progress on the ground should be scrapped. Re-bid them once issues have been resolved or complete them through public funds and if viable, bid out for Operations and Maintenance.
   • Periodic reviews: Such reviews should ideally therefore be done frequently, perhaps once every three years.
   • Amend legislations: The Government may take early action to amend the Prevention of Corruption Act, 1988 which does not distinguish between genuine errors in decision-making and acts of corruption.
   • Optimal allocation of risks across PPP stakeholders: Project specific risks are rarely addressed by project implementation authorities in this “One-size-fits-all” approach.
   • Discouraged unsolicited proposals: As they bring information asymmetries into the procurement process and result in lack of transparency and fair and equal treatment of potential bidders in the procurement process.
     • Example: Swiss Challenge
2. Other solutions
   • Renegotiation Commission: To cater to dynamic needs of the infrastructure projects setting up hassle free institutional mechanism.
   • Recapitalization: Recapitalising the PSBs with stringent measure to ensure the folly of NPAs doesn’t return.
   • FTPT (first public than private) principle: Public investment upfront during the high risk period and then private investment during the low risk period
   • Rating private partners: A system of rating of private partners should be undertaken by the regulatory authority which would be of immense help in future contracting

 

India is currently in a global win-win situation with a large young population that will need good jobs and a huge pool of global savings that can be tapped for building out our infrastructure. PPPs are an important policy instrument that will enable India to compress time in this journey towards economic growth and development. A successful and growing stream of PPPs in infrastructure will go a long way in accelerating the country’s development process

DISINVESTMENT

Disinvestment means to the act of selling or liquidating of assets. The process of dilution of a government’s stake in a PSU (Public Sector Undertaking) is disinvestment.

Background

1. Initiation: Disinvestment in India began as a result of economic reforms in 1991.
2. Formalization: It was formalized in 1996 when the Divestment Commission was established to guide the government on non-strategic sector withdrawals.
3. Department of Disinvestment: Established in 1999 to handle government equity disinvestment in Central PSUs.
4. National Investment Fund (NIF): Formed in 2005 to channel proceeds from disinvestment. It aimed to allocate 75% of funds to social sector schemes, but this was modified in 2013 to provide more flexibility in fund usage due to economic challenges.

 

Current Incidences New Disinvestment Policy (2021 Budget): Sets a roadmap for disinvestment in non-strategic and strategic sectors. Aim: The government aims to generate ₹1,75,000 crore through disinvestment. Coverage: Includes Central Public Sector Enterprises (CPSEs), Public Sector Banks (PSBs), and Public Sector Insurance Companies. Sector Classification: Non-strategic Sectors: The government will exit all businesses. Strategic Sectors: Limited government presence in four areas: Atomic Energy, Space, and Defense Transport and Telecommunications Power, Petroleum, Coal, and Minerals Banking, Insurance, and Financial Services Aatmanirbhar Bharat Abhiyan: Incentivizes states to disinvest in their PSUs, with support from central funds. Budget 2021: Emphasizes monetization of public sector assets and targets significant disinvestment revenue. LIC IPO: The government plans to launch the initial public offering of Life Insurance Corporation (LIC) to generate funds.

 

Significance

1. For the Government:
   • Reduce Burden: Disinvestment reduces the burden of inefficient PSUs, turning them from liabilities into productive assets.

• Better Utilization of Funds: Disinvestment funds can be directed toward long-term goals like infrastructure development and social programs in health and education.
• Fiscal Health: It helps the government reduce its fiscal deficit by boosting non-debt capital receipts.
• Fund to Strengthen Infrastructure: Enables the government to raise funds for strengthening physical and social infrastructure.

1. For the Economy:
   • Effect on GDP: The national GDP and gross savings were negatively impacted by low returns from PSUs. Disinvestment can improve the contribution of these entities to GDP.
   • Low Capital Output Ratio: PSUs often suffer from low profits due to factors like underutilization of capacity, management issues, pricing policies, and lack of autonomy.
   • Loss of Asset Value: Continuous losses in PSUs reduce the value of public assets, making it critical to disinvest early to realize their value.
2. For PSUs:
   • Modernization: Strategic buyers may introduce advanced technology and management practices to drive PSU growth.
   • Reduced Failure Rate: Improved management can reduce the chances of PSU failure.
3. For Society:
   • Employment: Disinvestment may lead to job creation by encouraging private sector involvement and competition.
   • Funds for Social Welfare: Additional revenue generated can be redirected to welfare programs.
4. For Market:
   • High Competition: Increased competition can make it challenging for PSUs but also fosters better services and efficiency.
   • Better Quality Products and Services: Encourages competition, leading to improved products and services for consumers.

 

Issues with Disinvestment

1. For the Government:
   • Strategic and National Security Concerns: Disinvesting in critical sectors like oil may pose risks to energy security.
   • Wasteful Exercise: In some cases, the government might ask one PSU to buy shares of another, which does not fulfill the objective of disinvestment.

• Administrative Concerns: Loss-making units struggle to attract investment and lack a robust investment policy.
• Allegations of Corruption: Instances where PSUs are sold to preferred parties at undervalued prices, raising concerns over transparency.
  • Example: The sale of BALCO to Sterlite Industries for Rs. 551.5 crores. BALCO was profitable, with a turnover of Rs. 898 crores and a profit of Rs. 56 crores in 2000.

1. For Economy:
   • Fiscal Insecurity: Relying on disinvestment funds to bridge fiscal deficits is short-term and unsustainable.
   • Loss of Income: Selling profit-making PSUs like BPCL and LIC leads to a loss of regular revenue for the government.
2. For Society:
   • Social Security: Disinvestment may impact the social security of the labor force.
   • Loss of Jobs: Private sector-led boards may reduce staff for profitability.
   • Welfare Concerns: Private companies may prioritize profit over welfare activities, impacting services for poorer populations.

1. For Market:
   • Competitiveness: There are risks of monopolies as public sector monopolies transition into private monopolies.
   • Market Concerns: Weak market conditions may result in poor valuations for disinvestment deals.

 

Case Studies

1. Successful Case: Hindustan Zinc saw a significant increase in profits and capacity expansion under Vedanta’s management post-takeover in 2002.
2. Failure Case: VSNL, which had a robust cash reserve, was sold to Tata Group in 2000. After the sale, its operations and profitability were limited.
3. LIC Disinvestment Case: The government’s plan to sell part of its holding in LIC via an IPO.
   • Merits:
     • Improved efficiency and policy returns.
     • Increased competition may improve pricing and services.
     • Reduced government interference could benefit LIC’s financial health.
     • Continued sovereign guarantees might assure policyholders.
   • Demerits:
     • Concerns over disclosure, as LIC’s operations have been opaque.
     • IPO size may not match the depth of Indian markets, affecting liquidity.
     • Potential impact on public confidence due to privatization.

 

Way Forward for Disinvestment

• Time-Bound Programme: A structured timeline is essential to ensure transparency and efficiency in disinvestment activities, fostering consensus for genuine benefits.
• Focus on Monetization: Emphasis should be on monetizing assets rather than outright privatization to achieve a balanced approach.
• Caution Against Undervaluation: The government must avoid selling PSUs at undervalued prices, ensuring fair valuation for maximum returns.
• Asset Creation from Proceeds: Instead of using disinvestment proceeds to bridge revenue deficits, these funds should be directed toward creating new assets.
• Transparent Auction: Both domestic and international buyers should be allowed to bid openly, provided there are no strategic concerns.
• Policy-Based Disinvestment: The process should follow a well-defined policy, with clear guidelines for PSU privatization to avoid ad-hoc decisions.
• Better Targeting: Investments in PSUs should be directed to ensure social and strategic returns, especially in critical sectors like defense and natural resources.
• International Experience: India could learn from China and Singapore in using PSUs strategically rather than outright selling them.

COVID-19 pandemic has hit the Indian economy very hard. At once, due to lockdowns, Indian economy was dried out of funds. Economic activities got reduced drastically. At present, the Indian economy is in urgent need of a revenue stream so that all activities can go back to normal and disinvestment can play a pivotal role in it.

DEFICITS

Deficit is the amount by which the spending done in a budget surpasses the earnings. A government deficit is the amount of money in the budget by which the spending done by the government surpasses the revenue earned by it. This deficit presents a picture of the financial health of the economy.

There are main 3 types of deficits

1. Revenue Deficit
2. Fiscal Deficit
3. Primary Deficit

 

Revenue Deficit (RD)

• Definition: A revenue deficit refers to the surplus of the government’s revenue expenditure over the revenue receipts.
• Symbolize: This deficit symbolizes that what government earns on a day to day basis and what it spends on a day to day basis.
• Current data: Revenue deficit is targeted at 5.1% of GDP in 2021-22, which is lower than the revised estimate of 7.5% in 2020-21 (3.3% in 2019-20).

Consequences of Revenue Deficit

• Borrowing for consumption: RD actually means expenditure beyond the means. By implication, this results in borrowing. Loans are paid back with interest and this borrowing is usually for consumption expenditure.
• Reduction of assets: RD indicates dis-saving on government account because the government has to make up the uncovered gap by drawing upon capital receipts either through borrowing or through a sale of its assets (disinvestment).
• Inflationary situation: Since borrowed funds are used to meet consumption expenditure of the government, it leads to an inflationary situation in the economy with all its associated woes.
• Leads to more revenue deficit: It actually promotes a vicious cycle of problems related to revenue deficit. Large borrowings to meet revenue deficit will raise debt burden.
• Reduce confidence of investors: It looks like the government is unable to even run the revenue expenditure without borrowing. This reduces the confidence of investors on the government.

FRBM Act: The revenue deficit needs to be reduced to 0% of GDP according to the FRBM, hence swift measures need to be taken such as increasing the efficiency in working of government and reduce unnecessary spending.

Fiscal Deficit (FD)

• Definition: The fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing). A FD occurs when this expenditure exceeds the revenue generated.
• Symbolizes: FD serves as an indicator of how well the government is managing its finances.
• Current data: The government’s fiscal deficit has increased to 145.5% of the Budget Estimate (BE) at the end of December 2020 (accounting for the first nine months of the year 2020-21) mainly on account of lower revenue realisation.

 

Consequences of Fiscal Deficit

• Debt trap: FD is financed by borrowing which creates the problem of not only payment of interest but also of repayment of loans. Ultimately, the government may end up borrowing to finance even interest payment leading to the emergence of a vicious circle.
• Wasteful expenditure: High fiscal deficit generally leads to wasteful and unnecessary expenditure by the government. Leads to unnecessary debt.
• Inflationary pressure: As government borrows from RBI which meets this demand by the printing of more currency notes (called deficit financing), it results in circulation of more money which causes inflationary pressure in the economy.
• Partial use: The entire borrowing for FD is not available for growth and development of the economy because a part of it is used for interest payment.
• Diminishes future growth: Borrowing is, in fact, a financial burden on future generation to pay the loan and interest amount which slows down the growth of the economy.
• Increase Foreign Dependence: Government may borrow from rest of the world, which results in its dependence on other countries.
• Necessary evil: A high fiscal deficit can also be good for the economy if the money spent goes into the creation of productive assets like highways, roads, ports and airports that boost economic growth and result in job creation.
• FRBM Act: The FRBM Act, 2003 provides that the Centre should take appropriate measures to limit the fiscal deficit upto 3% of the GDP by 31st March, 2021.

• The NK Singh committee (set up in 2016) recommended that the government should target a fiscal deficit of 3% of the GDP in years up to 31st March, 2020, cut it to 2.8% in 2020-21 and to 2.5% by 2023.

 

Primary Deficit (PD)

• Definition: Primary deficit is referred to as the difference that exists between the fiscal deficit of the current year and the interest payment that was needed to be paid in the previous fiscal year.
• Symbolize: It symbolizes how much government is borrowing for interest payment of previous loans.
• Current data: In fiscal year 2021, the primary deficit as a share of GDP in India was projected to be over 1%. This figure stood at 0.9 percent in fiscal year 2019.
• Reverse equation: High PD is a good sign it means that borrowing is mainly for structural development and not for interest payment. While low PD is not a healthy sign as it shows that most of the FD is on account of interest payment.

 

Consequences of Fiscal Deficit

• No development: PD is only for interest payment leads to no further development.
• Reduce credibility: A low PD shows that government has a high burden of interest payment which reduce its credibility for future borrowing.
• More taxes: To pay previous interests and loans government may impose high taxes on citizens and corporates.
• Crowding out of fund: Government may borrow more to fix their previous liabilities, which may crowd out fund for private sector.

 

Way Forward

1. Measures to Reduce Government Deficit
   • Increased emphasis on tax-based revenues and appropriate measures to reduce tax evasion.
   • Disinvestment should be done where assets are not being used effectively.
   • Reduction in subsidies by the government will also help reduce the deficit.
   • Try and avoid unplanned expenditures.
   • Borrowing from domestic and external sources.
   • A broadened tax base may also help in reducing the government deficit.
2. NK Singh Committee recommend: Create an independent fiscal council so that it can review the fiscal target that was decided in the budget.
3. A new Act is needed: Because
   • The existing FRBM Act has proved ineffective.
   • It was suspended with impunity in 2009, for several years, during which the fiscal deficit went out of control.
   • There was also non-transparency which allowed the deficit to be seriously understated.
   • The lesson is not that fiscal rules are useless, but that the old Act was flawed, and we need something better.

An uncontrolled government deficit may lead to deterioration in the financial health of the economy. The agenda of the government should be to plan the revenues and expenditures such that the economy moves towards a balanced budget situation.

TRADE DEFICIT

A trade deficit occurs when a country’s imports exceed its exports over a certain period. It represents an outflow of domestic currency to foreign markets and is also called a negative balance of trade.

Background

Balance of Payments (BoP): Records transactions in goods, services, and assets between residents of a country and the rest of the world.

• Accounts in BoP:
  • Current Account: Deals with trade in goods, services, and transfer payments.
  • Capital Account: Related to investments and loans.
• Components of the Current Account:
  • Balance on Trade: The difference between export and import values in a given period.

Current Trends Status: India’s trade deficit rose to 87.5% to USD 192.41 billion in 2021-22, up from USD 102.63 billion the previous year. COVID-19 Impact: India saw reduced trade deficit during global trade disruptions, but the current fiscal year has been challenging. Trade Surplus with the U.S.: India had a trade surplus of USD 32.8 billion with the U.S. Largest Deficit with China: The trade deficit with China reached USD 72.9 billion in FY22, up from USD 44 billion in FY21. Exports to China: Declined by 31%, while imports from China grew by 12.75%. Top Imports: Include crude oil, gold, gems, and petroleum products. Top Exports: Include petroleum products, pearls & stones, iron, and steel.

 

India’s Trade Balance: Reasons for Trade Deficit

1. Economic Growth: In a growing economy, increased wealth leads to more imports and foreign investment, which can widen the trade deficit.
2. Increased Government Spending: Government spending can reduce national savings, increasing the trade deficit.
3. Exchange Rate Changes: Currency depreciation generally makes exports cheaper and imports more expensive, while appreciation has the opposite effect.
4. Production Limits: Domestic limitations in producing goods lead to higher imports.
5. Trade Policy: Policies can impact trade balances by either encouraging or restricting imports and exports.

 

INDIA’S TRADE BALANCE

Reasons of Trade Deficit to Occur 

Multiple factors have to be taken into consideration while understanding reasons behind deficit, such as:

• Economic growth: A large trade deficit can be an indicator of economic growth. In a growing economy, consumers have more wealth to import goods, leading to a trade deficit. A strong economy also brings in foreign investors, further widening the trade deficit.
• Increased government spending: An increase in government spending can lead to a diminishing saving and increasing the trade deficit.
• Changes in exchange rate: A change in the value of currency can impact the trade deficit. When a country’s currency depreciates, exports increase generally while a stronger currency favors more imports.
• Production Limits: Sometimes certain goods cannot be produced locally or it is cheaper to get them imported. This too leads to an increase in deficits if exports do not match up.
• Trade Policy: Trade policy also impacts deficits either by increasing them or reducing it or shifting it to another economy.

Benefits of a trade deficit	Harms of a trade deficit
It allows a country to consume more than it can produce It helps a country to avoid any shortfall in goods. It provides the countries with a comparative advantage during trade. It is beneficial as a whole for increasing global wealth. It allows space for foreign direct investment	For a developing country it might be harmful as more imports increase the fiscal deficit. It might lead to shrinkage in domestic industries. The country may end up providing ownership of its resources and assets to the foreign country due to the deficit. A higher trade deficit leads to a depreciation in the value of local currency.

Trade deficits are not inherently good or bad

• Positive Side: In case of a deficit, to make up for the shortfall, a developed economy like the USA can either borrow money from foreign lenders or permit foreign investment in U.S. assets. If used wisely, it will result in growth as has been seen in the past.
• Negative side: For a smaller country with a trade deficit, this greater degree of foreign direct investment can be risky. Many countries in East Asia—including Thailand, Indonesia, and Malaysia ran into East Asian crisis due to risks surrounding foreign capital in1990s.

 

Reasons behind the Present Trade Deficit:

1. Increase in Imports:
   • Oil import: Imports have increased due to energy sources — oil and coal. The demand for oil and the higher prices and the demand for coal due to domestic coal supply crunch increased the imports.
   • Domestic demand: Core imports also grew due to higher inflows of plastics, chemicals, electronics and vegetable oils due to domestic demands.
   • Demand of electronic good: Rising demand for electronic goods including mobile phones and computers contributed to rising import bills and widening trade deficit
   • Gold import: Demand and import of gold is also one prime reason for deficits.
2. Decrease in Exports:
   • Decrease in petroleum export: India’s petroleum exports have contracted. Experts say the fall in petroleum exports can be attributed to the windfall tax levied by the government on oil companies.
   • Recession in export destination: Exports of gems and jewelry were affected by muted consumer demand in several key markets. India exports plain gold and studded jewelry and the US is a key destination but US itself is in a technical recession
   • Slowdown in external demand: The slowdown in exports is due to an underlying slowdown in external demand with weakness seen in exports of engineering products, chemicals, pharmaceuticals, cotton yarn and plastic products.
   • Shift in consumption: Merchandise exports have decreased as there is again a shift in consumption from goods to services with the opening up of economies after the Covid-19 pandemic.
   • Stained supply chain: The Russia-Ukraine conflict and China’s slow easing of restrictions from its zero-Covid strategy have strained supply chains, further slowing merchandise trade and increasing logistic costs.

 

Impacts of a Trade Deficit

• Reduced prices: A country may have a trade deficit because it is more economical to purchase goods internationally than to produce them at home. This means that prices of consumer goods and services may decrease.
• Weakening currency: A trade deficit can depreciate a country’s currency and hence make imports costlier leading to imported inflation.
• Deflation: A country that has a trade deficit can also witness deflation where reduced demand leads to lower prices.
• Changes in employment: If a country imports more than it exports, unemployment may increase or the employment structure may shift to goods produced there.
• Decrease in GDP: Trade deficit is one factor used while calculating a country’s Gross Domestic Product (GDP). An increase in it may lead the GDP to decrease.

 

Government’s effort to balance trade

1. To boost exports:
   • Remission of Duties and Taxes on Exported Products (RoDTEP): To boost Indian exports, a WTO compliant RoDTEP scheme is brought in 2021. It is based on the globally accepted principle that taxes and duties should not be exported, this scheme is an improvement over Merchandise Exports from India Scheme (MEIS).
   • Production-Linked Incentive (PLI) scheme: It was announced in the Union Budget 2021-22 for 14 key sectors. The scheme provides incentives to companies on incremental sales for products manufactured in domestic units.
   • Infusion of capital in EXIM Bank: Government of India infused capital of 750 crore in Export-Import Bank of India (EXIM Bank) during the financial year 2021-22 by subscribing to its share capital.
   • Export Promotion Capital Goods (EPCG): In order to increase procurement of capital goods from indigenous manufacturers under the EPCG scheme, the government has reduced specific export obligations from 90 per cent to 75 percent of the normal export obligation.
2. To cut imports:
   • Oil Palm Mission: To reduce heavy dependence on import of edible oils, government has approved a new mission for palm oil to be known as the “National Mission on Edible Oils – Oil Palm (NMEO-OP)”
   • Sovereign Gold Bond: The Government of India introduced the Sovereign Gold Bond (SGB) Scheme to offer investors an alternative to physical gold and curb imports.
   • Make in India Scheme: Make in India scheme was launched to curb imports and promote exports.
   • Withdrawal from RCEP: India withdrew from RCEP to not let the trade deficit worsen through increase in imports.
   • SATAT Scheme and Ethanol Blending Scheme: To cut down crude oil imports SATAT initiative has been launched to promote the use of Compressed BioGas (CBG). Similarly blending of ethanol with petrol will also reduce import

 

Way Forward

• Substitution strategy: Top categories of Indian imports that can be effectively substituted with local products should be classified
• Stricter product standards: Should be implemented to cut down on mostly consumer goods imports.
• Expending schemes: Expanding the scope of performance-linked incentive (PLI) schemes to boost domestic manufacturing.
• Stricter non-tariff barriers: Against import sources such as China should be implemented.
• Case study: The success of the East Asian economies, particularly Taiwan and China, presents a viable case for the strategic use of Import-Substitution Industrialisation (ISI) policies, but only when applied alongside Export-oriented Industrialisation (EOI). So, steps need to be taken accordingly.