Living within your means
This is not an attempt to rate the budget or fathom its impact on the economy over the next year. Rather the objective is to analyze the budget of the country as we would the budget of a household or company.
But first let’s divert our attention for a moment to ScoreAlpha, our investment process. The primary pillars of our research methodology are a focus on operating cash flow and return on capital employed. Operating cash flow is the fuel for growth for a sound business. The operating cash flow or a part of it is reinvested in the company. If this capital in the business generates a return on capital higher than the cost of capital, then the company creates value for its shareholders. If a company fails to generate consistent operating cash flow then it must take on debt to meet its operating needs which puts it in vulnerable situation as it now needs financial support from lenders and equity holders just to continue operations. Further if it wishes to invest it must further take on debt or raise equity to invest as it does not generate any cash of its own. Such a company would qualify as rather poor business. And these are risks that we look out for in our research methodology.
Given the purpose and obligations of government, the second pillar i.e, return on capital is not relevant but we can apply the first pillar i.e., operating cash flows to the government of India and its finances. As per the budget presented in parliament this week the Union Government expects to receive net tax revenues of Rs 19.4 lakh crores in the FY23. Add to this number, dividends, interest and other revenue items and the government estimates total revenue receipts to amount to Rs 22.04 lakh crores. As against these revenue receipts the government expects its total expenditure to amount to Rs 39.45 lakh crores in FY23BE. This amounts to a gap of Rs 17.4 lakh crores between its means and its needs. To finance this gap, it must sell assets (disinvestment, privatization) borrow money from the market and from the public (small savings schemes). The fiscal deficit as we term it, it is estimated at Rs 16.61 lakh crores in FY23BE after accounting for the proceeds from sale of assets.
At this point we could say that to support and grow the economy - a plan that involves borrowing money every year to meet revenue and capital expenditure i.e, a fiscal deficit is not unusual. According to the CIA’s World Factbook estimates for 2017, only 47 out of 222 countries worldwide are not in a fiscal deficit. In our opinion, that number has increased due to the pandemic in 2021. As for India, we have been running a fiscal deficit pretty much for ever. This is not something individuals can do but the sovereign can, because the sovereign has the right to tax and can transfer liabilities from one generation to another. Further, if the sovereign borrows in its own currency, it can either inflate away the debt and keep printing money to balance the books.
As a citizen of India, it would be appropriate to ascertain if our revenue receipts match our revenue expenditure. Sadly, the answer to that is – no. The union expects revenue expenditure of Rs 31.94 lakh crores in FY23BE. In other words, the revenue deficit (revenue receipts less revenue expenditure) itself is Rs 9.91 lakh crores; the sovereign needs to borrow just to meet its running expenses. Note that the interest cost of the Government is estimated at Rs 9.40 lakh crores in FY23BE i.e over 40% of the government’s revenue goes solely towards meeting its interest obligations. In fact, the interest obligations, defence expenditure, salaries & pensions and subsidies put together equal the government’s revenue receipts. Just to make the point again this is not unique to this year’s budget this has been the state of our finances for several years now.
This leads us to a few conclusions. We must expand our tax base and tax net. The revenues accruing to the state are insufficient. We must be conscious of our fiscal deficit and the quantum of debt relative to the size of our economy - this number is now just under 90% of GDP. The cost of our profligacy will be imposed on future generations. Discipline in spending and a swing towards capital expenditure within our limited budgetary means are financial priorities. Further this annual ritual where individuals, businesses and industries plead for tax breaks from government must cease - our means are limited. Finally, stability in tax policy is underrated. Businesses and citizens cannot manage their affairs forever looking over their shoulder to changes in the budget in February every year. Stability in tax policy – direct and indirect taxes allow businesses to make their plans without being disrupted by the annual budget of the government. It is useful to think of the finances of the union not just in absolute term but also in relation to the size of the economy. Growth in the economy addresses our financial problems because even if we hold the trajectory of our deficits steady in absolute terms; the deficits begin to shrink relative to GDP. We have done that before and that is the pathway to a better financial situation.
Our target should be to glide the revenue deficit to zero or even a surplus. Borrowing by government should primarily be for capital expenditure. The fiscal deficit should be a counter cyclical policy instrument - rising when the economy requires support and contracting when the economy is doing well. Finally, we should be conscious of the aggregate debt to GDP - that is a burden we impose on future generations
Former US President Calvin Coolidge famously said and this bears repeating - “There is no dignity quite so impressive, and no independence quite so important, as living within your means.”
Or in the words of my standard 6 Hindi teacher “jitni chadar ho, utna hi pair phailana chahiye”
Above commentary is published in UTI Fund Watch (monthly factsheet) in the section of Update from CIO’s Desk, click here to refer to the factsheet.