In today’s Finshots, we discuss off-budget borrowings and how they affect a government’s finances.

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When the centre or state governments present their budgets they allocate blocks of money for different purposes. The expenditure list includes food, education, infrastructure, healthcare and a lot more. And this is taken care of by the government’s receipts in the form of taxes we pay.

But when these receipts aren’t enough to support routine and capital expenditure, governments borrow from the central bank. Or even raise money from the public in the form of bonds. A bond is like a loan you lend to the government trusting it to repay after a specified period with periodical interest payouts.

And this extra spending creates something called a fiscal deficit. The lower the fiscal deficit, the better it is for the government. It shows how prudent it is and also improves its creditworthiness. This means that if the government needs more money it can’t simply keep borrowing. So, what does it do?

It resorts to something called an off-budget borrowing. You could think of this as debt which doesn’t directly show up in its books. And that’s because it doesn’t borrow directly at all. Instead, it just asks another public entity to borrow on its behalf while servicing the principal and interest payments from the budget itself.

Just look at the Food Corporation of India (FCI), our country’s main grain handling agency. It gets subsidies from the government which go into providing food and grains to over 800 million people. So it’s one of the largest users of budgetary revenue. Despite that, it needs a lot more money to keep its schemes running.

For instance, this year the Union Budget allocated ₹1.97 lakh crore to the FCI. Although it may seem like a huge allocation, it’s actually about 30% lower than last year. So it may need to go to banks or borrow from the National Small Savings Fund, where all the public money from small saving schemes gets pooled.

On the face of it, it may seem like the government has reduced its expenditure. But if the FCI borrows and cannot repay on its own, the government has to ultimately do it later. And that’s likely, simply because the FCI doesn’t make enough money to actually repay all of its debts.

And this could spell long term trouble. Because when you have debt and it doesn't show up on the books, it makes things less transparent. Governments could go into a debt spiral, making it a perfect recipe for hindering future growth.

A recent paper by the Centre for Social and Economic Progress (CSEP), throws light on how off-budget borrowings may have gotten states to go off their debt tracks. For context, Andhra Pradesh and Telangana, two southern states are major off-budget borrowers. And their debt-to-GDP ratios for FY21 are mostly underestimated because they only consider direct borrowings. But if you consider off-budget borrowings these ratios go up by close to 10%.

So what’s the way out of this hazy problem, you ask?

Well, one way to increase transparency could be by levelling up inconsistent accounting practices. You see, most states address off-budget borrowings by either including them as a part of their total debt or tabling them as a separate statement along with the annual budget. But some state laws like those in Madhya Pradesh, Rajasthan, Tamil Nadu and Jharkhand have indirect references to off-budget borrowings. So it may be hard to compare where a state stands.

And the central government is actually trying to change this. Starting FY22 it told states to consider off-budget borrowings as a part of their debt ceilings itself. A debt ceiling is how much states can borrow depending on their GSDP (Gross State Domestic Product). This means that states will have a much smaller borrowing window.

Now, this can be hard on them considering that they have to spend heavily on food and power subsidies and infuse capital for infrastructure. But the centre has also tried to make this easier by letting them spread the burden of their off-budget borrowings for the first year over the next four years.

Another solution to help the centre and states quit the off-budget borrowing habit is to actually increase their tax base and bring in more sources of revenue. That’s the reason why the centre is actually simplifying tax filing. With the introduction of a new exemption-less tax regime which also has lower tax rates, it hopes that more folks in the tax net come forward to pay taxes. This way the government can actually reduce compliance costs as it won’t have to scrutinise thousands of income tax returns to check if taxpayers claimed false exemptions. So they get to keep and utilise tax revenues more efficiently.

But governments also need to rationalise expenditure. Reducing subsidies may not be the most effective way to do this. Because government entities that rely on these subsidies might then resort to external borrowing. Giving rise to a vicious cycle of off-budget borrowings.

Instead, they could focus on judicious spending through programs similar to the Gati Shakti Mission. It aims to try and get different departments to coordinate with each other so that capital is used resourcefully. So, inefficient practices like digging up the same stretches of roads multiple times to lay pipelines and telecom cables take a back seat and save monetary resources.

But until governments fix this, the only prudent way to deal with off-budget borrowings is to address data gaps. A clear reconciliation between how much governments are borrowing versus how much they’re disclosing could be the first step towards tackling the bigger problem at hand. With clarity, reducing off-budget borrowings will naturally follow.

Until then…

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