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Economy Mar 6, 2012

Budget 2012 primer: What does govt spend money on?

By Arjun Parthasarathy

(This is the second of a multiple-part series on government revenues, expenditure and fiscal deficits. To read the first story in the series, click here).

A fiscally constrained government that is using most of its resources for paying interest and subsidies and spending on defence and social schemes will find it difficult to earmark funds for much needed infrastructure building. It remains to be seen if the government can give a thrust to infrastructure in Budget 2012.

Interest payments constitute the highest single expenditure for the government in any given year. The government pays interest on its debt, which includes government securities, treasury bills, small savings, deposits and provident funds and on other securities, such as fertiliser bonds and oil bonds that were issued a few years back in lieu of subsidy payments (a practice that has since been discontinued). The interest payments, at an absolute level, keep growing as the government consistently runs a fiscal deficit, which is financed by market borrowings.

Rising interest payments prevent the government from spending on growth drivers such as infrastructure.

The interest payments for the financial year ending March 2012 was budgeted at Rs 267,986 crore against Rs 240,757 crore the previous year -- an increase of 11 percent. Interest payments will be higher for the current financial year, as the government has issued bonds for around Rs 4,30,000 crore, on which interest needs to be paid.

The total stock of government securities outstanding was Rs 24,25,000 crore at the end of March 2011, and adding Rs 4,30,000 crore, to securities outstanding will result in the total moving up to Rs 28,55,000 crore at the end of this financial year. The average cost of borrowing for the government was over 8.25 percent in 2011-12 and interest payments on account of higher debt outstanding will move up by a minimum of Rs 35,000 crore.

On a relative basis, interest payments as a percentage of GDP was budgeted at 2.98 percent for 2011-12 against 3.06 percent a year ago. The fact that GDP growth figures have been revised downwards by 1.5 percentage points from 9 percent to 7.5 percent will push up the interest payments-to-GDP ratio higher. Rising interest payments prevent the government from spending on growth drivers such as infrastructure.

Subsidy payments are the second single-largest expenditure for the government. The government pays out subsidies on food, fuel and fertilisers, and had budgeted a subsidy bill of Rs 143,570 crore in the current financial year, against a subsidy bill of Rs 1,64,153 crore, the previous year. But the subsidy bill is likely to overshoot budget estimates by a minimum of Rs 1,00,000 crore taking the total subsidy for fiscal 2011-12 to around Rs 250,000 crore. The sharp rise in oil prices, which have jumped by 18 percent year on year, has upset budget forecasts.

The government has been unable to control its subsidy payments, which have been trending higher over the years. The subsidy bill has gone up from levels of Rs 57,000 crore in the year ending March 2007 to Rs 2,50,000 crore this financial year- a five-fold increase. There is an urgent need to bring down subsidy payments through policy reforms. On a relative basis, subsidies as a percentage of GDP have been running at over 2 percent of GDP over the past three years and are likely to remain that way this year as well.

The government, if it wants to show a lower subsidy bill in 2012-13, will have to carry out serious reforms on subsidies as oil prices are trending at close to three-year highs and, in all likelihood, will trend higher on the back of economic growth across emerging countries. Brent crude at $125 per barrel will be the base for arriving at a subsidy figure in the budget against last year's levels of around $100 a barrel.

Defence is the third-largest expenditure of the government. Defence spending accounts for around 1.8 percent of GDP as per budget estimates of 2011-12. The government had projected an increase of 12 percent in defence expenditure for the current financial year from a year ago.

The government goes by the projections of the Planning Commission for its outlay on infrastructure. The capital outlay that goes into creation of assets is pegged at around 1.6 percent of GDP for this financial year. The country follows a series of five-year plans for spending on infrastructure and the 11th five-year plan will end this year. The government had earmarked Rs 40,000 crore for rural employment in last year's Budget, and is likely to maintain the same figure for 2012-13. Spending on rural employment takes away much needed resources for building infrastructure. Similarly, any loan waiver program will eat into capital spending on infrastructure.

Arjun Parthasarathy is the editor of www.investorsareidiots.com, a web site for investors.

by Arjun Parthasarathy

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