Monday, 25 February, 2008

Higher fuel bills? Don't worry about it now, your kids will pay

The ruling United Progressive Alliance (UPA) governments increasingly common practice of moving big-ticket items of expenditure off its balance sheet is threatening to undermine the objectives of a five-year-old legislation, supported by all political parties, to cap fiscal profligacy.

Ironically, when the Fiscal Responsibility and Budget Management Act, or FRBM, was legislated in 2003, it was aimed, among other things, at making government accounting more transparent and getting the current generation to pay its bills.

The legislation was prompted by the thinking that its failure to live within its means would force the government to borrow larger sums of money. And to service interest payments on these, the government would have no choice but to dip into future revenues money that could have otherwise been used to fund development programmes.

Ironically, despite the legislation, that is just what has happened. In the last four years, the unprecedented spurt in tax revenues has not been able to match the spike in government expenditureespecially on account of the UPAs decision to absorb the impact of the nearly fourfold increase in international oil prices and not pass it on to the consumer.

To work around the provisions of FRBM, the government has increasingly employed a practice, used by previous regimes, toothough in smaller measureof moving the accumulating expenditure off-balance-sheetby consolidating them and issuing bonds that will be redeemable 15-20 years later.

However, the problem does not end with issuing bonds. The manner in which its impact has been neutralized in the governments account books is turning out be very controversial.

This is where fraud in fisc (fiscal deficit) is taking place (and) decidedly, the burden will fall on future generations, said Yashwant Sinha, who was the finance minister in the previous National Democratic Alliance government, who successfully piloted the FRBM legislation through Parliament.

Sinha is not the only one to question the consequences of the governments methods to get around paying for its bills by issuing bonds. The comptroller and auditor general of India, or CAG, an independent watchdog of the governments accounts, claims the deficit (difference between income and expenditure offset by borrowing) is being understated.

In December, CAG brought out its annual report on the Union governments finances (for 2006-07), where it showed the deficit to be higher than that projected by the government in its documents such as Budget at a Glance. Both CAG and government documents use the same accounting data to calculate deficits.

The issue is critical because FRBM mandates the government to cap its deficits and CAGs report, tabled in Parliament on 7 December, said the government had overshot it in 2006-07. Interestingly, on the same day, the last day of the winter session, finance minister P. Chidambaram tabled a statement explaining the difference between the CAGs deficit and the governments.

According to CAG, the revenue deficit for 2006-07 was Rs1.32 trillion, 65% higher than the governments number of Rs80,221 crore. When it came to fiscal deficit, CAG concluded the number was Rs1.82 trillion, 28% higher than the Rs1.42 trillion calculated by the Centre.

The primary reason for the difference?is because CAG added oil bonds of Rs24,122 crore and securities issued to Food Corporation of India (FCI) worth Rs16,200 crore to the deficit. Chidambaram defended the governments approach with the statement: Issue of securities/bonds/write off of loans in the government accounts, being in the nature of non-cash transactions, have been netted against matching amounts and hence excluded from the calculations deriving revenue and fiscal deficits.

A retired finance ministry official, who was closely associated with drafting FRBM and who did not wish to be identified, argued that the legislation was a landmark one in Indian economic historyan attempt to make governments live within their means and let people know the true state of affairs. It played an important role in nudging international credit rating agencies to upgrade Indias sovereign ratings, which translated into lower interest rates for Indian companies overseas borrowings, the official added.

Government accounts are done on cash basis as, not the accrual basis of accounting for commercial establishments. Accordingly, entries that involve an immediate inflow or outgo of cash are acknowledged. Accrual accounting acknowledges any transactions done in the current year even if inflow of money happens at a future date.

Oil bonds, for instance, are issued to public sector oil refiners such as Indian Oil Corp. Ltd to offset losses incurred while selling petrol, diesel, kerosene and liquefied natural gas below cost. In each of these cases, the companies sell the bonds in the market; the bonds will eventually be redeemed by the government.

Some officials in CAG disagreed with Chidambarams explanation to Parliament.

There are no explicit accounting rules that prevent the government from netting non-cash transactions, said a CAG official who did not want to be identified. However, an accounting entry in the cash accounting system automatically implies a liability that has show up in the calculation of deficit, the official added.

Why is the governments calculation of deficit as presented in the Budget at a glance so important? This is because it poses a macroeconomic risk. Since government borrowings mostly mean adding money supply to the system, it could stoke inflationary pressures.

Our forecasts stick to the governments deficit numbers for both fiscal and revenue deficit targets as that is the convention, said Sonal Varma, economist at Mumbai office of Lehman Brothers.

However, the share of off-balance-sheet subsidies in the form of food, fertilizer and oil bonds is rising and this is a risk as it can lead to continued fiscal imbalances, Varma said.

Off-balance-sheet items are a blow to the transparency in government accounts. For instance, the size of the revenue deficit indicates the extent of government spending (or dis-saving, as it is called) to finance present consumption. An underestimate hikes the extent of the problem.

Moreover, the duration of the recently issued bonds is causing concern. For instance, the current fiscal marks the first time that fertilizer bonds worth a total of Rs7,500 crore have been issued in two tranches with different yields and tenures: 8.3% over 16 years in the first case and 7.95% over 18 years in the second.

FRBM aimed to restrict the issuance of bonds such as the ones given to oil and fertilizer firms as a way to get over temporary problems by capping their tenure at five years. The current life of bonds, 15-20 years, transfers current problems to another generation, said Sinha.