25 Things PM Modi Did Not Tell You About the Indian Economy

narendra modi

The Prime Minister, Shri Narendra Modi addressing the Nation on the occasion of 71st Independence Day from the ramparts of Red Fort, in Delhi on August 15, 2017.

In a speech last week, Prime Minister Narendra Modi, offered several data points to tell his fellow countrymen, that all is well with the Indian economy. And those who didn’t think so were essentially being needlessly pessimistic, he suggested.

Now only if he had bothered to look at data points beyond those he chose to offer, a totally different situation would have emerged. In this piece, I offer many data points to show that all is not well with the Indian economy.

1) Let’s start with the loans disbursed by banks during the course of this year. Let’s look at non-food credit to start with. These are the loans given out by banks after we have adjusted for food credit or loans given to the Food Corporation of India and other state procurement agencies, for buying rice and wheat directly from farmers at the minimum support price (MSP) for the public distribution system. Take a look at Figure 1.

Figure 1: 

The Figure 1 clearly shows that the total amount of non-food credit given by banks during the course of this year has been in negative territory. This basically means that on the whole banks haven’t given a single rupee of a loan. The situation is the worse it has been in five years. Non-food credit consists of loans given to agriculture, industry, services and retail sectors, respectively.

Let’s take a look at each of these sectors.

2) Let’s take a look at Figure 2, which plots the loans given by banks to agriculture and allied activities.

Figure 2: 

Loans given to agriculture and allied activities are in negative territory during the course of this year. Again, this basically means that on the whole banks haven’t given a single rupee of a loan to agriculture. In technical terms, their loan book to agriculture has shrunk. Is this possibly because of farm loans being waived off by state governments, that only time will tell.

3) Let’s take a look at Figure 3, which plots the loans given banks to industry.

Figure 3: 

Figure 3 makes it clear that loans given to industry by banks continue to shrink. This isn’t surprising given the huge amount of bad loans accumulated by banks on lending to industry. Banks still don’t trust the industry.

4) Let’s take a look at Figure 4, which plots the loans given by banks to the services sector.

Figure 4: 

This comes in as a major surprise, loans given to services have shrunk majorly during this financial year. Services constitute half of the Indian economy. If the firms operating in this sector are not interested in borrowing, then how can the Indian economy possibly be doing well?

5) Let’s take a look at Figure 5, which plots the retail loans given by banks during this financial year.

Figure 5: 

Retail loans are the only loans which have been in positive territory during the course of this year. Nevertheless, they have been more or less at the same level over the last few years.

This, despite the fact that interest rates have come down dramatically. If people are not willing to borrow more even at lower interest rates, how can things be alright with the Indian economy, is a question well worth asking.

Sadly, Prime Minister Modi, did not include any of these data points in his speech and presentation.

6) The latest Consumer Confidence Survey of the Reserve Bank of India (RBI) for September 2017, states: “Households’ current perceptions on the general economic situation remained in the pessimistic zone for four successive quarters, with the outlook worsening… The employment situation has been the biggest cause of worry for respondents, with sentiment plunging further into the pessimistic zone; the outlook on employment has also weakened.”

7) Take a look at Figure 6, which plots the cement production over the years.

Figure 6: 

Cement production is down this year, in comparison to the previous year. This tells us clearly that the construction and the real estate industry continue to be in trouble. These industries are huge employers of people, especially those who have low-skills.

8) The commissioning of new projects has slowed down. As Centre for Monitoring Indian Economy, which tracks this data, points out: “Projects worth Rs 512 billion were commissioned during the quarter ended September 2017. In the coming weeks this estimate is expected to rise. It could reach about Rs 700 billion. Even if this happens, this would be the lowest commissioning of projects during the Modi government’s tenure so far.” 

9) There has been a fall in new investment proposals. As Centre for Monitoring Indian Economy, which tracks this data, points out: “Projects worth Rs.845 billion were proposed during the quarter ended September 2017. This is the lowest level of intentions to invest seen in a quarter during the tenure of the Modi government.”

10) There has been a huge fall in the profit of companies. As Centre for Monitoring Indian Economy points out: “We infer this and other related nuggets of information from the financial statements of 1,127 listed companies… Profit before taxes of these companies fell by 27.9 per cent over their level a year ago.”

11) Take a look at Figure 7, which plots the trade deficit or the difference between exports and imports.

Figure 7: 

The trade deficit has jumped up majorly during the course of this financial year. This as I have explained beforehas primarily been on account of a jump in non-oil non gold non silver imports, in the aftermath of demonetisation. The unseen negative effects of demonetisation continue to impact the economy.

12) The growth in private consumption expenditure is at a six-quarter low. As the RBI Monetary Policy Statement pointed out: “Of the constituents of aggregate demand, growth in private consumption expenditure was at a six-quarter low in Q1 of 2017-18 [April to June 2017].”

13) As the RBI Monetary Policy Statement further pointed out: “India’s export growth continued to be lower than that of other emerging economies such as Brazil, Indonesia, South Korea, Turkey and Vietnam, some of which have benefited from the global commodity price rebound.”

14) Take a look at Figure 8 which plots the investment to GDP ratio.

Figure 8: 

The investment to GDP ratio has improved a little in the period of three months ending June 2017, but it continues to remain very low. As the RBI Monetary Policy Statement pointed out: “The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates.”

15) Now let’s take a look at Figure 9, which plots the growth of the non-government part of the GDP.

Figure 9: 

Figure 9 basically plots the growth of the non-government part of the economy, which typically constitutes 87 to 92 per cent of the economy. The growth of the non-government part of the economy has fallen to around a little over 4 per cent. This extremely important detail did not find a place anywhere in Prime Minister Modi’s speech.

If the non-government part of the economy is growing at such a slow rate, how will jobs for the one million youth entering the workforce every month, ever be created.

16) The situation becomes even more worrisome if we look at Figure 10.

Figure 10: 

As is clear from Figure 10, the growth rate of industry in general and manufacturing and construction in particular is at a five-year low. The manufacturing part of industry grew at 1.17 per cent during April to June 2017, whereas construction grew by 2 per cent during the same period.

This is a big reason to worry simply because manufacturing and construction have the potential to create new jobs. An estimate made by Crisil Research suggests that in construction 12 workers are typically required to create Rs 10 lakh worth of output. In case of manufacturing it is seven workers.

17) Take a look at Figure 11, which basically shows that labour intensive sectors have slowed down between January to June 2017.

Figure 11: 

As Crisil Research points out in a recent research note: “In the past two quarters, three sectors have grown much faster than GDP: 1) Trade, hotels, transport, communication and services related to broadcasting; 2) Electricity, gas, water supply and other utilities, and 3) Public administration, defence and other services. Of these, only the trade, hotels and restaurants sub-sector is labour intensive, requiring about 6 workers to produce Rs 10 lakh worth of output. But the share of this sub-sector in total output is low at ~12%. In contrast, a fast growing sector like public administration, defence and other personal services, despite having a larger share in output, has low labour intensity of only 3. And sectors with higher labour intensity – such as construction (12) and manufacturing (7) – have been undershooting overall GDP growth.”

It needs to be said here that public administration, defence and other personal services sector is basically a proxy for the government. And the government has stopped creating jobs.

18) Take a look at Figure 12.

Figure 12: 

Figure 12 plots the index of industrial production (IIP), a measure of the industrial activity in the country. It also plots manufacturing, which forms more than three-fourths of IIP. The growth of both these measures has been in low single digits for a while now and is clearly a reason to worry.

19) Take a look at Figure 13, which basically plots the consumption of petroleum products, over the years.

Figure 13: 

The consumption of petroleum products has more or less been flat in comparison to the last financial year. This is another good indicator of slowing economic growth.

20) Take a look at Figure 14, which plots the sale of commercial vehicles during the course of this financial year.

Figure 14: 

Commercial vehicle sales, which are a very good indicator of a pick-up in the industrial part of the economy. Commercial vehicle sales this year were lower than they were last year.

21) Take a look at Figure 15. It plots the fiscal deficit ratio of the government over the years.

Figure 15: 

As can be seen from Figure 15, in the first five months of the current financial year, 96 per cent of the annual fiscal deficit has already been crossed. Fiscal deficit is the difference between what a government earns and what it spends. Why is the fiscal deficit during the first five months of the year at such a high level? The answer lies in the fact that the economic growth is slowing down and the government is trying to drive up growth, by spending more.

22) Take a look at Figure 16.

Figure 16: 

It tells us that the increase in government expenditure has been a greater part of the increase in GDP over the last two years. For the period April to June 2015, the increase in government expenditure made up for around 1.3 per cent of the increase in GDP during that period. Since then it has jumped to 39.2 per cent between January to March 2017 and 34.1 per cent between April to June 2017.

So, the government is spending more and more in order to drive economic growth. This again shows that the government in its actions does believe that the economic growth is slowing down, but PM Modi won’t say so in his public posturing.

23) Take a look at Figure 17, it plots the bad loans ratio of public sector banks.

Figure 17: 

Figure 17, basically plots the gross non-performing advances ratio or simply put. the bad loans ratio of public sector banks, over the years. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. There has been a huge jump in bad loans of public sector banks over the last two years.

On October 7, the Reserve Bank of India imposed restrictions on the banking activities of Oriental Bank of Commerce (OBC). OBC was the seventh public sector bank on which restrictions have been placed. Now, one-third of public sector banks have restrictions in place. And all is well with the Indian economy?

24) Take a look at Table 1.

Table 1:

Gross NPAs (in Rs Crore) Gross Advances Gross non-performing advances ratio
Indian Overseas Bank 35,098 1,40,459 24.99%
IDBI Ltd. 44,753 1,90,826 23.45%
Central Bank of India 27,251 1,39,399 19.55%
UCO Bank 22,541 1,19,724 18.83%
Bank of Maharashtra 17,189 95,515 18.00%
Dena Bank 12,619 72,575 17.39%
United Bank of India 10,952 66,139 16.56%
Oriental Bank of Commerce 22,859 1,57,706 14.49%
Bank of India 52,045 3,66,482 14.20%
Allahabad Bank 20,688 1,50,753 13.72%
Punjab National Bank 55,370 4,19,493 13.20%
Andhra Bank 17,670 1,36,846 12.91%
Corporation Bank 17,045 1,40,357 12.14%
Union Bank of India 33,712 2,86,467 11.77%
Bank of Baroda 42,719 3,83,259 11.15%
Punjab & Sind Bank 6,298 58335 10.80%
Canara Bank 34,202 3,42,009 10.00%

Source: Author calculations on Indian Banks’ Association data.(The table does not include the associate banks of the State Bank of India which were merged into it).

What does Table 1 tell us? It tells us that many public sector banks are in a big mess on the bad loans front. Banks like Indian Overseas Bank and IDBI with bad loans ratio of 24.99 per cent and 23.45 per cent, will pull down the performance of any big bank they are merged with.

Even the big banks like Union Bank of India, Bank of Baroda, Punjab National Bank and Canara Bank, have a bad loans ratio of 10 per cent or more. If and when weaker banks are merged with these banks, their performance will only deteriorate. The question to ask is, why are many of these banks still being allowed to operate?

25) The capacity utilisation of 805 manufacturing companies tracked by the RBI OBICUS survey fell to 71.2 per cent during the period April to June 2017. This is the lowest in seven quarters.

I guess I will stop at this. There are many other economic indicators which can be used to point out that all is not well with the Indian economy. (For more details on how PM Modi cherry picked data to build a positive economic narrative, you can click here and here). Of course, this is not to say that there are no positive economic indicators right now. But the negative indicators far outnumber the positive ones.

As I keep saying, the first step towards solving a problem is recognising that it exists. But that doesn’t seem to be the case with PM Modi. In his world, all is well.

The column originally appeared on Equitymaster on October 9, 2017.

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Dear Mr Urjit Patel, Have You Ever Heard of Wasim Barelvi?

For a man who rarely and barely speaks, the Reserve Bank of India governor Urjit Patel spoke quite a lot in the press conference that happened after the first monetary policy of this financial year was presented on April 6, 2017.

In response to the question, “What do you think are the implications of the farm loan waiver schemes and is it a cause of concern for the RBI?”, Patel had this to say: “There are several conceptual issues, if one were to put one’s hat as an economist on. I think it undermines an honest credit culture, it impacts credit discipline, it blunts incentives for future borrowers to repay, in other words, waivers engender moral hazard. It also entails at the end of the day transfer from tax payers to borrowers. If on account of this, overall Government borrowing goes up, yields on Government bonds also are impacted. Thereafter it can also lead to the crowding out of private borrowers as higher government borrowing can lead to an increase in cost of borrowing for others. I think we need to create a consensus such that loan waiver promises are eschewed, otherwise sub-sovereign fiscal challenges in this context could eventually affect the national balance sheet.

Basically in one paragraph, Patel summarised all that is wrong about waiving off farmer loans or in fact, any loan. I had discussed most of these issues in my Diary dated April 5, 2017, last week.

The first issue that a waive-off of bank loans creates is that of a moral hazard. The economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.”

This basically means that once the farmer sees a loan being waived off today, he will wait for elections in the future for the newer loans he takes on to be waived off as well. Essentially, he will see little incentive in repaying loans that he takes on in the future. Or as Patel put it: “it impacts credit discipline, it blunts incentives for future borrowers to repay”.

The second issue that a waive-off of bank loans creates is that it can lead to the crowding out of private borrowers. The state government waiving off the bank loans needs to compensate banks which had given these loans. In case of the Uttar Pradesh government which recently wrote off the loans, this amounts to Rs 36,359 crore. The government will have to borrow this amount in order to pay the banks simply because its earnings are lesser than its expenditure.

When a government borrows more, it leaves a lesser amount of money for others to borrow. This can push up interest rates and as Patel aptly puts it, “higher government borrowing can lead to an increase in cost of borrowing for others”. What also needs to be taken into account here is the fact that the Uttar Pradesh government waive-off might inspire other state governments to waive-off farmer loans as well. This will mean greater government borrowing and a higher crowding out effect.

It will also lead to the overall fiscal deficit of the nation (i.e. fiscal deficits of state governments plus that of the central government) going up. Fiscal deficit is the difference between what a government earns and what it spends during the course of a year. The difference between the earning and the spending is met through borrowing.

If several state governments waive-off bank loans and borrow more, it will lead to the national fiscal deficit going up. As Patel puts it: “sub-sovereign fiscal challenges in this context could eventually affect the national balance sheet.”

So far so good. It is nice to see the RBI governor speak out against what is essentially bad economics and can screw up the economic and financial situation of the nation. Nevertheless, the question is where has all this forthrightness been when it comes to the issue of corporate defaults and loan write-offs?

As is well known, corporates have defaulted on several lakhs of crore of bank loans over the years. These defaulters have been treated with kid gloves. Over the years, a huge amount of corporate loans have been written off. It needs to be mentioned here that loans written off are different from loans being waived off, at least theoretically.

This is something I discuss in detail in my new book India’s Big Government—The Intrusive State and How It is Hurting Us. The loans written off are no longer be a part of the balance sheet of the bank, even though they can be recovered in the future. There is no chance of recovery in case of a loan that is waived off. Hence, theoretically there is a difference between a write-off and a waive-off.

Let’s try and understand this issue in a little more detail. Let’s first take the case of the State Bank of India. As of April 1, 2015, the bank had Rs 56,725 crore of bad loans, or gross NPAs. During the course of the year, Rs 4,389 crore of bad loans was recovered. At the same time, the bank wrote off Rs 15,763 crore of bad loans. The loans written off would no longer be a part of the balance sheet of the bank, even though they could be recovered in the future.

As we can see in case of the State Bank of India, the total amount of the loans written off during the year was more than three times the total amount of the loans recovered. That tells us the sad state of the loan recovery process. There were also fresh bad loans that were added to the balance sheet of the bank during the course of the year, and by March 31, 2016, the total bad loans of the bank had slipped to Rs. 98,173 crore.

Or take a look at Table 1 which shows the overall scenario comparing write-offs and recoveries.

Table 1: Write-offs versus recoveries of public sector banks

Write-offs versus recoveries of public sector banks

Year Writes-Offs
(in Rs. Crore)
Recoveries
(in Rs. Crore)
2015-2016 59,547 39,534
2014-2015 52,542 41,236
2013-2014 34,409 33,698
2012-2013 27,231 19,832

Source: Reserve Bank of India

As is clear from Table 1, write-offs of public sector banks have been greater than their recoveries. And the absolute difference between the two has only gone up over the years. A bulk of these loans are corporate loans. Hence, it is safe to say on the basis of this data that a large portion of corporate loans which are written-off are over the years, are practically waived-off because banks are really not able to recover these loans.

Hence, if the issue of moral hazard comes up with farmer loan waive-offs, it also comes up with corporate loan write-offs. And given that a large portion of what is technically a write-off is actually a waive-off, the case for moral hazard in this case is really very strong. The RBI governor Patel could have talked about this as well, given that he has been in office for more than seven months now.

Over and above this, corporate loan write-offs have led to the situation of diminishing bank capital. This has led to the central government having to recapitalise the public sector banks over the years. Between 2009 and now, the amount of money put in has been greater than Rs 1,30,000 crore. This money is ultimately borrowed by the government and leads to crowding out, higher interest rates and a weaker national balance sheet. All these issues pointed out by Patel in case of farm loan waive-offs apply to corporate write-offs as well.

But a word hasn’t been spoken against them.

In the Diary dated March 22, 2017, I had quoted the British author George Orwell. In his book Animal Farm, Orwell writes: “All animals are equal, but some animals are more equal than others.” The point being, if there is a moral hazard for the farmer, there is also one for corporates. And if the RBI governor has pointed out one, he should have pointed out the other as well.

Over the weekend, I came across a very interesting couplet which makes the same point has George Orwell did in the Animal Farm, but rather more forcefully.

As Wasim Barelvi, probably the greatest Urdu poet alive today, writes:

Garib lehron par pehren bithaye jaate hain
samundaron ki talashi koi nahi leta”.

(I couldn’t come across a good translation of this couplet. Hence, I am leaving it untranslated. But its basic meaning is the same as the line from Orwell’s Animal Farm, quoted earlier).

The column originally appeared on April 10, 2017 on Equitymaster

Why Waiving Off UP Farm Loans is a Bad Idea, Nevertheless…

In the run-up to the assembly elections in Uttar Pradesh, the Bhartiya Janata Party had promised that it would waive off crop loans taken by the small and marginal farmers of the state.

Political parties promising to waive off crop loans is nothing new. Before the 2009, Lok Sabha elections, the Congress led United Progressive Alliance government had carried out a similar exercise.

The question, as always, is how much is it going to cost and where is the money going to come from? The State Bank of India in a research report expects the cost of waiving off crop loans to small and marginal farmers to come at around Rs 27,419.7 crore. How have they arrived at this estimate? The total loans given by banks to the agriculture sector in Uttar Pradesh stands at Rs 86,241 crore.

As the SBI report points out: “According to RBI data (2012), 31% of the direct agriculture finance went to marginal and small farmers (landholdings upto 2.5 acres). Taking this as a proxy for Uttar Pradesh as well, approximately Rs 27,419.70 crore will have to be waived off in case loan waiver scheme is implemented for the small and marginal farmers for all banks (scheduled commercial banks, cooperative banks and primary agricultural cooperative societies).”

The SBI estimate suggests that the loan waive off will cost around Rs 27,420 crore. The banks which had given these loans will have to be compensated for this waive off. The union agriculture minister Radha Mohan Singh in a series of tweets on March 17,2017, made it clear that the union government wasn’t picking up the tab. In one of the tweets he said that, if any state government waives off the loans of small and marginal farmers using the state treasury, the move should be welcomed. Hence, from the looks of it, if the loans are waived off, the Uttar Pradesh government will have to pick up the tab.

Take a look at Figure 1. It shows the fiscal deficit of the Uttar Pradesh government over the years. A government is said to run a fiscal deficit if its revenue is less than its expenditure. This difference the government makes up through borrowing money.

As can be seen from Figure 1, the fiscal deficit of the state has risen at a much faster pace than its gross domestic product over the years. While, the state GDP has jumped by 59.3 per cent between 2011-2012 and 2015-2016, the fiscal deficit has jumped from 2.13 per cent of the state GDP to 5.57 per cent of the state GDP, at a much faster pace.

Figure 1:

Year Gross Fiscal Deficit State GDP at current prices (in Rs crore) Fiscal Deficit as a percentage of GDP
2016-2017* 49,961 12,36,655^^ 4.04%^
2015-2016** 64,317 11,53,795 5.57%
2014-2015 32,513 10,43,371 3.12%
2013-2014 23,680 9,44146 2.51%
2012-2013 19,240 8,22,903 2.34%
2011-2012 15,430 7,24,049 2.13%

*budget estimate
**revised estimate
Source: /or GSDP, the RBI’s Database on Indian Economy.
For deficit, budget.up.nic.in and RBI Reports on State Finances
^Source: www.business-standard.com
^^ Calculated on the basis of 4.04 per cent and Rs 49,961 crore fiscal deficit estimates.

In 2016-2017 which is the current financial year, the fiscal deficit of the state government is expected to be at 4.04 per cent of the state GDP. In absolute terms it was expected to be at Rs 49,961 crore. If the Uttar Pradesh government waives off the loans during the course of this financial year, then the fiscal deficit in absolute terms would shoot to Rs 77,381 crore (Rs 49,961crore plus Rs 27,420 crore of the waive off), assuming that expenditure and revenue assumptions made at the beginning of the year, hold true. This works out to 6.26 per cent of the state’s gross domestic product and is a really high figure.

So, the question is can Uttar Pradesh government afford this? The answer clearly is no. Can the union government in Delhi afford it? The answer is yes. Rs 27,420 crore is not a large amount for it. But if it goes ahead and finances this write off, similar demands will be raised by other states as well. And given that the Bhartiya Janata Party governments now govern large parts of the country, it will be very difficult for the union government to say no.

Over and above the one-time cost to the state government, there is also the question of moral hazard. The economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.”

This basically means that once the farmer sees a loan being waived off today, he will wait for elections in the future for the newer loans he takes on to be waived off as well. Essentially, he will see little incentive in repaying loans that he takes on in the future.

As the SBI Chairperson Arundhati Bhattacharya said recently: “We feel that in case of a (farm) loan waiver there is always a fall in credit discipline because the people who get the waiver have expectations of future waivers as well. As such future loans given often remain unpaid… Today, the loans will come back as the government will pay for it but when we disburse loans again then the farmers will wait for the next elections expecting another waiver.”

All this makes tremendous sense. But given that we live in the age of whataboutery, you, dear reader, may comeback and ask us: “But what about the fact that banks have written off lakhs of crore of loans that they gave to corporates? If they can do that, why can’t they waive off Rs 27,420 crore?”

This is a very good question for which I really don’t have a straightforward answer. In situations like these I suggest, dear reader, that you read George Orwell. As he famously wrote in the Animal Farm: “All animals are equal, but some animals are more equal than others”.

The point is that if there is a moral hazard for the farmer, there is also one for the corporates.

For today, we will leave it at that.

The column was originally published on March 22, 2016

Fiscal Deficit for First Four Months of 2016-2017 is Highest in Eight Years

At the end of every month the Controller General of Accounts (CGA) declares the fiscal deficit of the government, up until the previous month of the financial year. Fiscal deficit is the difference between what a government earns and what it spends.

Hence, as of August 31, 2016, the CGA declared the fiscal deficit number for the period April to July 2016. During the period the fiscal deficit of the central government was at Rs 3,93,487 crore. This was at 73.7 per cent of the annual target for the financial year and is the highest in eight years.

Fiscal deficit a percentage of annual target 

Take a look at the above chart. It shows the fiscal deficit as a percentage of the annual target, for the first four months of the financial year, over a period last twelve years. It is clear that only in July 2007 and July 2008, was the fiscal deficit as a percentage of the annual target, at a higher level in comparison to where it is at during the course of this financial year. The year 2008 was the year when the financial crisis started and the government tried to beat the impending slowdown by spending much more than it what normally did during the first four months of the year.

Another point that needs to be mentioned here is that expenditure of the government is front loaded whereas a major chunk of its revenues start to come in only in the second half of the year. Even with this disclaimer, the fiscal deficit for the first four months of this financial year is worrying, given that one of the biggest expenditure items of the year, the extra salaries and pensions that the government needs to pay to its current and former employees after accepting the recommendations of the Seventh Pay Commission, kicks in only from August 2016.

This higher fiscal deficit is also visible in the gross domestic product number for the first three months of the financial year (April to June 2016). One way of measuring the gross domestic product (GDP) is to calculate the total expenditure by adding the consumption expenditure, the government expenditure, investments and the net exports (exports minus imports).

For the three-month period between April to June 2016, the government expenditure went up by 18.8 per cent (in real terms). This helped the GDP grow by 7.1 per cent. Without this push from the government, the growth would have been much slower at 5.7 per cent, as per Nomura.

The trouble is that the government doesn’t have an unlimited amount of money and if it is spending money without earning it first, it’s bound to push up its fiscal deficit. A higher fiscal deficit comes with its own set of problems, from higher inflation to higher interest rates.

Further, if the government wants to achieve the fiscal deficit target of 3.5 per cent of the GDP, that it set at the time of presenting the budget, it will have to be a little more aggressive about raising its revenues.

Take the case of the disinvestment target for 2016-2017. It has been set at Rs 56,500 crore. The way it has worked in the previous years is that the government has waited all through the year for the stock market sentiment to improve. And then towards the end of the year, the Life Insurance Corporation of India, has been encouraged to buy what the government has had to sell.

In 2015-2016, of the disinvestment target of Rs 69,500 crore, only around Rs 25,312.6 crore was earned. Of this amount, a major chunk came from the Life Insurance Corporation of India. From the looks of it, something similar may happen this year as well. The Life Insurance Corporation picking up shares being sold by the government is hardly genuine disinvestment, with the money moving from one arm of the government to another.

It is worth pointing out here that timing the market by trying to sell when the stock market is peaking, is very difficult to achieve. And the same applies to the government as well. An ideal strategy would be sell the government stake in companies, little by little almost every month. This wait for the market to pick up is not the best way to operate. The moment any disinvestment of shares stops being an event, will be the day, this strategy will really take off.

Further, given its ambitions in the infrastructure sector, the Modi government needs to look at newer ways of raising revenue. One such way is by selling land. As the Economic Survey of 2015-2016 points out: “Most public sector firms occupy relatively large tracts of land in desirable locations. Parts of this land can be converted into land banks.”

These land banks can then be sold in order to raise revenues for the government. This money can go into a sort of an infrastructure fund which can be used to finance the ambitious plans of the government when it comes to roads and railways.

Of course, for this to happen, the reluctance of the bureaucrats to sell land has to be overcome. This reluctance, the Economic Survey comes in large part from the “the fear of ‘causing pecuniary gain’ to the other side.” And this fear will not be so easy to get rid of.

(The column originally appeared in Vivek Kaul’s Diary on September 6, 2016)

Jaitley’s Fiscal Deficit Numbers Don’t Really Add Up

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

Dear Reader,

By the time you read this piece, you would have been bombarded with a huge amount of analysis on the budget the finance minister Arun Jaitley presented yesterday.

Nevertheless, most such analysis misses out on carefully looking at the fiscal deficit number, which is basically what the budget is all about. Most other things that finance ministers talk about in their budget speeches, they can talk about on any other day of the year as well.

In fact, regular readers would know that I have been sceptical about the ability of the government to meet its fiscal deficit target. Fiscal deficit is the difference between what a government earns and what it spends during the course of any year. The difference is met through borrowing.

While presenting the budget last year, the finance minister Jaitley had said that the government expects to achieve a fiscal deficit target of 3.5% of GDP for 2016-2017 and 3% of GDP for 2017-2018.

In the budget presented yesterday Jaitley said that: “I have weighed the policy options

and decided that prudence lies in adhering to the fiscal targets. Consequently, the fiscal deficit in RE[revised estimate] 2015-16 and BE[budget estimate] 2016-17 have been retained at 3.9% and 3.5% of GDP respectively.”
The question is how realistic is the 3.5% of GDP fiscal deficit target for the next financial year? There are essentially three inputs that go into making the fiscal deficit number. The total receipts of the government, the total expenditure of the government and the nominal GDP number that has been assumed for the next financial year. Nominal GDP is the GDP which hasn’t been adjusted for inflation.

Let’s start with the receipts number. Jaitley has assumed that the government plans to collect Rs 56,500 crore through the disinvestment route. Of this, Rs 36,000 crore will come from the government selling shares in the companies its own and Rs 20,500 crore from the stakes that it has in non-government companies.

The total number assumed to come in through the disinvestment route is more than double of the Rs 25,312 crore that the government collected through the route this financial year. It needs to be pointed out here that a substantial part of this came from the Life Insurance Corporation(LIC) of India picking up stakes in government owned companies. Honestly that can’t be called disinvestment. It is money moving from one arm of the government to another.

Second, last year the government had assumed that Rs 69,500 crore would come in through disinvestment. Ultimately, only Rs 25,312 crore has been collected and that also after LIC had to come to the rescue. One excuse offered for the government going slow on disinvestment was low commodity prices. Commodity prices continue to remain low.

Given this, the Rs 56,500 crore disinvestment number is an overestimate like was the case last year as well.

The government has also assumed that it will earn Rs 98,994.93 crore from the telecom sector. This receipt comes under the entry “other communication services” and is primarily the money the government will earn through telecom spectrum auctions. Again, like is the case with disinvestment receipts, this number is a huge jump from the Rs 57,383.89 crore that the government managed to collect this year.

Given, the past record of the government, these assumptions are clearly looking overoptimistic. Also, they help in under-declaring the fiscal deficit. As per IMF norms, any kind of asset sales by the government needs to be treated as a financing item and not as a receipt as the Indian government does. In the process the government manages to come up with a lower fiscal deficit number.

Now let’s take a look at the expenditure front. There is no clarity on how much allocation the government has made towards implementing the recommendations of the Seventh Pay Commission. As Jaitley said during his speech: “the Seventh Central Pay Commission has submitted its Report. Following the past practice, a Committee has been constituted to examine the Report and give its recommendations. In the meantime, I have made necessary interim provisions in the Budget.”

The finance minister didn’t get into any more details. Nevertheless, one can use the numbers given in the budget and see if the right kind of allocation has been made. During 2015-2016, the government’s salary and pension bill (excluding Railways) is expected to be at Rs 1.85 lakh crore.

In 2016-2017, the government’s salary and pension bill has been budgeted at around Rs 2.25 lakh crore. This is Rs 40,000 crore more than the 2015-2016 number.

The Seventh Pay Commission recommendations come into force from January 1, 2016. The Seventh Finance Commission had said that its recommendations would cost the government Rs 73,650 crore during the first year. To this one would have add the cost of Pay Commission recommendations between January and March 2016, which would be needed to be paid as arrears to the government employees and pensioners.

This works out to Rs 18,412.5 crore (Rs 73,650 crore divided by four). Hence, the total extra allocation towards implementing the recommendations of the Seventh Pay Commission should have been around Rs 92,000 crore (Rs 74,650 crore plus Rs 18,412.5 crore). The actual increase in allocation towards salaries and pensions is only around Rs 40,000 crore.

What does this tell us? The government is probably not in the mood to pass on the entire increase in salaries and pensions during the course of 2016-2017. If it does that, then it will have to pay arrears in the years to come and that will add to the government expenditure and hence, the fiscal deficit. So to that extent the fiscal deficit is being under-declared at this moment.

Also, the implementation of one rank one pension in the defence forces is expected to push the pension bill up, by Rs 10,000 crore. And that will also add to the salary and the pension bill of the government.

Further, as I have pointed out in the past, more than Rs 1,00,000 crore of food and fertilizer subsidy bills remain unpaid.  And that is how it continues to be. The allocation to food and fertilizer subsidy has fallen from Rs 2.12 lakh crore in 2015-2016 to Rs 2.05 lakh crore in 2016-2017.

What does this mean? It means that while the government will pay the Rs 1,00,000 lakh crore of pending food and fertilizer subsidy bills, it will then have to postpone paying a large part of the food and fertilizer subsidy expenditure that is incurred during the next financial year.

The government follows the cash accounting system and only acknowledges expenses once payment has been made. This has led to a situation where subsidy payments to Food Corporation of India(FCI) and fertilizer companies remain unpaid. The money has been spent by FCI and the fertilizer companies towards subsidy, but remains unpaid by the government, and hence is not acknowledged as an expenditure.

The question is where does FCI get this money from? It borrows from the financial market. Why does the market lend money to FCI? It does that because it knows that it is effectively lending money to the Indian government. Hence, this subsidy expenditure has already been incurred by the government but has not been accounted for.

This essentially leads to a lower fiscal deficit number. Further, the absolute fiscal deficit number of Rs 5,33,904 crore looks very unrealistic given that the receipts of the government have been overstated while the expenditure has been understated.

Now let’s talk about the denominator in the fiscal deficit number, the nominal GDP. The nominal GDP for 2016-2017 has been assumed to be at Rs 15,065,010 crore assuming 11% growth over the 2015-2016 number. How realistic is this assumption? In 2015-2016, the nominal GDP is expected to grow at 8.6%. Given this, how realistic is an assumption of 11% nominal GDP growth for 2016-2017?

To conclude, it is safe to say that Jaitley’s fiscal deficit number is not believable. As the American professor Aaron Levenstein once said: “Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital.”

What Jaitley has managed to conceal is vital.

The column originally appeared on the Vivek Kaul Diary on March 1, 2016

 

 

What the GDP numbers tell us about the fiscal deficit

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
The Central Statistics Office(CSO) has published the economic growth numbers for the period October to December 2015. It has also put out the economic growth projection for the current financial year i.e. 2015-2016 (April 1, 2015 to March 31, 2016).

The Indian economy grew by 7.3% during the period October to December 2015. It is projected to grow at 7.6% during 2015-2016. Economic growth is measured by the growth in the gross domestic product(GDP). But GDP is a theoretical construct. There are many high frequency economic data indicators which tell us very clearly that there is no way that the country is growing at the rate at which the government wants us to believe it is.

Much has been written about the fact that India’s economic growth numbers can’t be possibly right and given that I wanted to discuss something else, but equally important in this column.

The GDP growth is declared in several forms. When CSO talks about the Indian economy growing by 7.6%, during the course of the year, it is talking about real GDP growth. Real GDP growth is essentially adjusted for inflation. The economic growth which is not adjusted for inflation is known as the nominal GDP growth. The nominal GDP growth for the current financial year is expected to be at 8.6%. Typically, the difference between nominal and real GDP growth is greater than this.

When calculating the fiscal deficit, the government uses the nominal GDP. This is because the revenue as well as the expenditure of the government are not adjusted for the prevailing inflation. Fiscal deficit is the difference between what a government earns and what it spends during the course of the year.

When the finance minister Arun Jaitley presented the budget in last February, he had set a fiscal deficit target of 3.9% of the GDP. The GDP here is the nominal GDP. There are essentially two numbers in the fiscal deficit calculation—the absolute fiscal deficit number and the nominal GDP number.

The absolute fiscal deficit number for this year was set at Rs 5,55,649 crore. The nominal GDP number in the budget was assumed to be at Rs 14,108,945 crore. It was assumed that the nominal GDP would grow by 11.5% in comparison to the nominal GDP in 2014-2015, which was at Rs 12,653,762 crore.

The growth of 11.5% in nominal GDP has not materialised and now close to the end of this financial year, the government thinks that the nominal GDP growth will be at a much lower 8.6%. And this is precisely what has upset the fiscal deficit calculations of the government. A growth of 8.6% means that the nominal GDP for 2015-2016 will come in at Rs 13,741,986 crore.

If the government maintains an absolute fiscal deficit of Rs 5,55,649 crore, then the fiscal deficit as a proportion of the nominal GDP will come in at 4.04% of the GDP. In order to maintain the fiscal deficit at 3.9% of the GDP, the government will have to cut down the fiscal deficit by around Rs 20,000 crore, assuming all other projections remain the same.

A fiscal deficit of 4.04% of the GDP is higher than 3.90% of the GDP, but not significantly higher. But that is not what has got the government worrying. In fact, the finance minister Arun Jaitley had talked about fiscal consolidation in the two budget speeches he has made till date in July 2014 and February 2015. Fiscal consolidation is the reduction of the fiscal deficit.

In July 2014 Jaitley had said: “We need to introduce fiscal prudence that will lead to fiscal consolidation and discipline. Fiscal prudence to me is of paramount importance because of considerations of inter-generational equity. We cannot leave behind a legacy of debt for our future generations. We cannot go on spending today which would be financed by taxation at a future date.”

He had further said: One fails only when one stops trying. My Road map for fiscal consolidation is a fiscal deficit of 3.6 per cent [of the GDP] for 2015-16 and 3 per cent for 2016-17.”

In the speech he made in February 2015, he postponed this target by a year and said that the government will achieve a fiscal deficit of 3.5% of GDP in 2016-17; and 3% of GDP in 2017-18.

The point being that the government had originally envisaged achieving a fiscal deficit of 3.6% of GDP during this financial year. This target was postponed by a year and the government set itself a much easier target of 3.9% of GDP. And given this, it is very important that the government achieve this much easier target, if it wants people to take it seriously in the future on the fiscal deficit front.

Further, it is worth pointing out here that typically if the government were to follow the international norms of declaring the fiscal deficit and not include disinvestment proceeds as a revenue item but a financing item, the fiscal deficit for 2015-2016 would be at 4.4% of the GDP. Also, the 3.9% of GDP fiscal deficit target does not include subsidy payments of more than Rs 1,00,000 crore that need to be made for fertilizer and food subsidies.

The government can achieve a 3.9% of GDP fiscal deficit target, by increasing its revenue and cutting down on its expenditure. The government has been trying to increase its revenue by increasing the excise duty on petrol and diesel. Three such hikes have been made since January 2016. This has led to a situation where oil prices have fallen dramatically but petrol and diesel prices in India have actually risen over the last one year.

The petrol price in Mumbai as of now is Rs 66.05 per litre. The price as of last February was at Rs 63.9 per litre. The price of the Indian basket of crude oil during the same period has fallen by more than 44%.

While the government continues to raise the excise duty on petrol and diesel, it continues to own a 11.2% stake in cigarette maker ITC. This stake as of yesterday’s closing price was worth Rs 28,256 crore. What is so strategic about owning a stake in a cigarette company and at the same time run advertisements trying to tell the country at large that it consumption of tobacco is injurious to health? Why can’t this stake be sold and the money used for better purposes?

This is something that the government needs to explain.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on February 9, 2016.

 

Mr Jaitley’s Search for a One-Handed Economist

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
Give me a one-handed economist,” quipped the American president Harry Truman, many years back. “All my economists say, ‘on the one hand…on the other’.”

The finance minister Arun Jaitley is currently probably going through the one-handed economist phase as well. There has been a huge debate going on, in the media, whether the government should relax the fiscal deficit target of 3.5% of gross domestic product for the next financial year i.e. 2016-2017, when it presents its budget later this month. Fiscal deficit is the difference between what a government earns and what it spends.

Economists, as usual, are divided on it. Some like the idea of government spending more in order to revive the slow economic growth (or so they like to believe). Others have been highlighting the negative consequences of the government spending more.

This has left Jaitley, who has no background in either finance or economics, and was a part-time politician and a full-time layer, until few years back, confused. As he recently said: “I’ve been consulting all shades of opinion. This is the first time I’ve come across people holding sharply divided views. Each one has a strong argument in his favour.”

The Chief Economic Adviser to the finance ministry, Arvind Subramanian, has been in favour of the government spending more. In the Mid-Year Economic Analysis released in December 2015, Subrmanian had suggested that in a scenario of lower than expected economic growth (as measured by the real/nominal GDP growth) “if the government sticks to the path for fiscal consolidation, that would further detract from demand.” Further, “consolidation of the magnitude contemplated by the government… could weaken a softening economy”. Fiscal consolidation is essentially the reduction of fiscal deficit.

The finance minister Arun Jaitley had talked about fiscal consolidation in the two budget speeches he has made till date in July 2014 and February 2015. In the first speech he said that the government is aiming to achieve a fiscal deficit target of 3% of gross domestic product(GDP) in 2016-2017.

In the speech he made in February 2015, he postponed this target by a year and said that the government will achieve a fiscal deficit of 3.5% of GDP in 2016-17; and 3% of GDP in 2017-18.  Now there is pressure on the finance minister to abandon the fiscal deficit target of 3.5% of the GDP set for 2016-2017, from one set of economists and the industry.

The trouble is another set of economists does not agree with this. Economist Arvind Panagariya, who happens to be the vice chairman of the NITI Aayog said in January 2016: “I personally don’t think we should be tinkering with the deficit as a percentage of GDP.”
Raghuram Rajan, the governor of the Reserve Bank of India, has also been an advocate of the government sticking to a path of fiscal consolidation. He reiterated the same in a recent speech as well as the monetary policy statement released last week.

One of the interesting points that Rajan made was that India’s overall fiscal deficit position has deteriorated. As he said: “The consolidated fiscal deficit of the state and centre in India is by far the largest among countries we like to compare ourselves with; presently only Brazil, a country in difficulty, rivals us on this measure. According to IMF estimates (which is what the global investor sees), our consolidated fiscal deficit went up from 7 percent in 2014 to 7.2 percent in 2015. So we actually expanded the aggregate deficit in the last calendar year. With UDAY, the scheme to revive state power distribution companies, coming into operation in the next fiscal, it is unlikely that states will be shrinking their deficits, which puts pressure on the centre to adjust more.”

One reason why government’s numbers are different from IMF numbers is because the government of India under-declares its fiscal deficit. How does it do it? The government recognises the disinvestment of shares in public sector units as a revenue rather than as a financing item.

As economist Rajeev Malik of CLSA put it in a recent column in the Mint: “India tends to under-report its fiscal deficit because it counts divestment and other asset sales as revenue rather than a financing item, as is practised by the International Monetary Fund (IMF). Thus, the FY16 budget deficit target—adjusted for divestment—was actually 4.4% of GDP, not 3.9% as officially reported.”

Rating agencies remain strangely silent on this self-serving approach,” Malik validly points out.

What complicates the situation further is that the government follows the cash accounting system and only acknowledges expenses once payment has been made. This has led to a situation where subsidy payments to Food Corporation of India(FCI) and fertilizer companies remain unpaid. The money has been spent by FCI and the fertilizer companies but remains unpaid by the government, and hence is not acknowledged as an expenditure.

The question is where does FCI get this money from? It borrows from the financial market. Why does the market lend money to FCI? It does that because it knows that it is effectively lending money to the Indian government. Hence, this subsidy expenditure has already been incurred by the government but has not been accounted for.

As economist M Govinda Rao put it in a recent column in The Financial Express: “In fact, the cash accounting system hides the real fiscal deficit which is much higher as substantial subsidy payments to Food Corporation of India and fertiliser companies are yet to be disbursed.”

While Jaitley may keep debating whether or not to abandon the fiscal deficit target that he set previously, he needs to tell us clearly what is India’s real fiscal deficit. If that means that he doesn’t get around to meeting the target.

Getting back to Rajan, the RBI governor also raised the question, whether the extra economic growth that will come in because of the government abandoning its fiscal deficit target and spending more, be worth it.

As Rajan said: “Perhaps Brazil offers a salutary lesson. Only a few years ago, the world was applauding the country’s thriving democracy, its robust economic growth, and the enormous strides it was making in reducing inequality. It grew at 7.6 percent in 2010…Paradoxical as it may seem, Brazil tried to grow too fast. The 7.6 percent growth came on the back of substantial stimulus after the global financial crisis.”

In fact, India tried the same strategy in the aftermath of the financial crisis, with the government coming up with a substantial economic stimulus. While this lifted the economic growth for the next few years, it led to a huge increase in corporate debt and high inflation, the aftermaths of which the country is still facing.

The column originally appeared in the Vivek Kaul Diary on Equitymaster on February 8, 2016