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Rising role of off-budget borrowings

Center’s true fiscal deficit was at six-year high of 6.3% of GDP in FY19



Extra-budgetary resources (EBR) or financing fiscal spending through off-budget borrowings is nothing new. EBR is

included in the definition of debt, but is not part of fiscal deficit. However, the excessive reliance of the central

government (CG) on EBR in recent years demands caution. Reported fiscal deficit (RFD) needs to be carefully topped up

with (net) borrowings of various government agencies to arrive at a true adjusted fiscal deficit (adj. FD) of the center.



In this note, we estimate that the adj. FD of the CG stood at 6.3% of GDP in FY19, much higher than the RFD of 3.4%. Our

calculations suggest that the CG’s adj. FD increased from a nine-year low of 4.8% in FY17 to 5.4% in FY18 and further to a

six-year high of 6.3% of GDP in FY19. Further details suggest that the outstanding arrears on account of subsidies were

at a decade-high of 1.3% of GDP (or INR2.5t) in FY19, while the off-budget capital spending was 1.6% of GDP (or

INR3.0t), more than 3x the average size of 0.5% of GDP during the two decades up to FY17.



The combined FD of the general government (center + states) thus was at a seven-year high of 8.8% of GDP in FY19, as

against the RFD of 5.9%. According to our

estimates,

household net financial savings were broadly unchanged at ~6.7%

of GDP in FY19, implying that the government’s net borrowings were >130% of household surplus – highest since the

late-1990s. These facts not only douse any case for a fiscal stimulus but also explain the ineffectiveness of monetary

easing.

Of late, the central government has resorted massively to various agencies to

finance its fiscal spending. Financing fiscal spending through off-budget borrowings

(called EBR) is nothing new. However, over-reliance on EBR suggests that the RFD

must be carefully topped up with (net) borrowings of various government agencies

to arrive at the true adj. FD of the central government.

According to a statement issued by the Comptroller Auditor General (CAG) in its

2016-17

report

on Compliance of the FRBM Act,

“…Government has increasingly

resorted to off-budget financing for revenue as well as capital spending…”

Such

reports for 2017-18 and 2018-19 are not yet available. According to a Jul’19 report

in the

Economic Times,

in a presentation to the 15

th

Finance Commission, the CAG

re-calculated the fiscal deficit for 2017-18 after accounting for the extra-budgetary

resources. According to the CAG presentation, fiscal deficit for 2017-18 was at 5.85%

of GDP, as against RFD of 3.46% for the same period.

In this note, we estimate

the adjusted fiscal deficit of

India’s central government

during the past two

decades up to FY19 after

incorporating the off-

budget transactions.

In this note, we estimate the adj. FD of India’s central government for the past two

decades up to FY19 after incorporating (a) the outstanding arrears on account of

various subsidies (off-budget revenue spending) and (b) off-budget capital spending

done by five government agencies – National Bank for Agriculture and Rural

Development (NABARD), National Highway Authority of India (NHAI), Power Finance

Corporation (PFC), Indian Railways Finance Corporation (IRFC) and REC Ltd – and GoI

fully-serviced bonds (raised by agencies other than the five mentioned above). We

thus also estimate the adjusted revenue deficit (adj. RD) of the center.

Nikhil Gupta – Research Analyst

(Nikhil.Gupta@MotilalOswal.com); +91 22 6129 1555

Yaswi Agarwal

– Research Analyst

(Yaswi.Agarwal@motilaloswal.com); +91 22 7193 4196

Investors are advised to refer through important disclosures made at the last page of the Research Report.

Motilal Oswal research is available on

www.motilaloswal.com/Institutional-Equities,

Bloomberg, Thomson Reuters, Factset and S&P Capital.

FUEL

Exhibit 1:

Detailed analysis of the estimation of adjusted fiscal deficit of India’s central government

INR b

Reported revenue deficit (RRD)

Off-budget revenue spending

Food subsidies

Fuel subsidies@

Fertilizer subsidies

Adjusted revenue deficit (Adj. RD)

Unit

INRb

% of GDP

INRb

INRb

INRb

INRb

INRb

% of GDP

INRb

% of GDP

INRb

INRb

INRb

INRb

INRb

INRb

INRb

INRb

% of GDP

INRb

% of GDP

INRb

% of GDP

INRb

FY17

3,164

2.06

1,329

723

125

391

4,403

2.87

2,192

1.43

763

258

301

21

189

(75)

70

2,956

1.92

5,356

3.49

7,358

4.79

153,624

FY18

4,436

2.59

1,698

1,266

170

262

6,134

3.59

1,475

0.86

1,700

331

471

353

386

162

0

3,175

1.86

5,911

3.46

9,309

5.45

170,950

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FY19

4,453

2.34

2,494

1,883

349

262*

6,947

3.65

2,001

1.05

2,984

652

631

530

400

377

358

4,984

2.62

6,454

3.39

11,931

6.28

190,102

Reported capital deficit (RCD)

Off-budget capital spending

NABARD

NHAI

PFC

IRFC

REC

GoI fully-serviced bonds#

Adjusted capital deficit (Adj. CD)

Reported fiscal deficit (RFD)

Adjusted fiscal deficit (Adj. FD)

Nominal GDP

Memo item:

Recapitalization of PSBs^

INRb

0

800

1,060

@ Recoverable reported by IOCL, HPCL and BPCL from the government on account of subsidies

* Assuming that the arrears on account of fertilizer subsidies remain unchanged at FY18 levels

# Excluding GoI fully serviced bonds raised by companies included in this study

^ Recapitalization of PSBs is netted out as infused equity is immediately invested in government securities and is included in the demand of

the concerned department of the government. Thus, it is not included in our estimate of adjusted fiscal deficit

Source: Controller General of Accounts (CGA), Capitaline, Union Budget documents, Company’s Annual reports, RBI, MOFSL

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Estimating adjusted revenue deficit

The government stopped

issuing special securities

post FY10 and the

responsibility to procure

funds for the unpaid

subsidy was left to OMCs,

FCI and fertilizer companies.

The central government provides price-related subsidies on three major

consumption items – food, fertilizer and fuel (petroleum products). Apart from

these, the government provides other non-price-related subsidies (including interest

subsidies). Until FY05, a large majority of the subsidy burden was almost entirely

incorporated in the budgets. However, as oil prices started rising from 2005 – from

an average of USD39.2/bbl in FY05 to USD55.7/bbl in FY06 – the government began

issuing special securities to the oil marketing companies (OMCs). Along with the rise

in crude oil prices, the fertilizer subsidy bill was also pushed higher since natural gas

became expensive. This gave rise to carryover liabilities of fertilizer subsidy, against

which the government issued special securities in FY08 and FY09. These special

securities were akin to EBR, which gets included in the definition of debt but not of

the fiscal deficit. Post FY10, however, the government stopped issuing these special

securities. It does not mean that the government started clearing their subsidy bills

in full. Instead, the OMCs, Food Corporation of India (FCI) and various fertilizer

companies were required to make arrangements to procure the necessary funds for

the unpaid subsidy burden. These entities borrowed heavily from banks until

recently and started issuing market securities in the past 3-4 years. Unpaid arrears

on account of subsidies thus are not a new phenomenon.

Exhibit 2:

Total subsidy bill including outstanding arrears

(% of GDP)

Budgeted subsidy bill

Off-budget subsidies

4.3

3.5

2.6

1.8

1.2

0.5

0.0

1.2

1.3

1.9

0.2

1.7

1.7

0.2

1.6

1.5

1.9

1.2

1.3

2.0

2.1

0.7

1.4

2.3

2.2

2.2

2.5

2.6

2.3

2.1

1.9

2.7

0.5

2.7

0.4

1.0

Total subsidy bill

3.6

1.0

3.4

1.1

3.0

0.9

2.7

0.8

2.4

0.9

1.5

2.3

1.0

1.3

2.6

1.3

1.3

0.1 0.7

1.3

1.4

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19

Source: Union Budget documents, CGA, CAG, Company Annual reports, Department of Fertilizers, MOFSL

Total subsidy burden,

including the unpaid

arrears, amounted to 2.6%

of GDP in FY19 – the highest

in three years. The adjusted

revenue deficit of the

center thus was 3.7% of

GDP, as against RFD of 2.3%

in FY19.

The quantum of these off-budget subsidies, however, has increased recently,

because of which it is important to incorporate such transactions in the reported

revenue spending and estimate the adjusted revenue deficit to get the true picture.

Notably, while the reported subsidy bill at 1.26% of GDP in FY19 was the lowest

since FY01, off-budget subsidy burden – according to our calculations – was 1.31%

of GDP in FY19, slightly higher than the reported subsidy bill and also the highest

in a decade (and the second-highest in the past two decades, barring 1.97% of GDP

in FY09). Total subsidy burden, including the unpaid arrears, thus amounted to

2.58% of GDP – the highest in three years

(Exhibit 2).

If so, adjusted revenue deficit

of the center was 3.7% of GDP, as against RFD of 2.3% in FY19 (see

Exhibit 1

above).

Higher total subsidies are almost entirely attributed to unpaid food subsidy, due to

which the FCI has increased its debt massively. Fuel & fertilizer subsidies – as a

percentage of GDP – have declined in recent years.

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Estimating off-budget capital spending

Apart from off-budget subsidies, the government has also recently increased its

reliance on agencies to undertake capital spending (or fiscal investments). Again,

this is nothing new. The entire objective of creating these agencies was to undertake

investment programs on behalf of the central government. However, the recent

surge in dependence on such agencies demands deeper analysis, which we have

provided in this note.

Our estimates of off-budget capital spending includes only six items – annual (net)

borrowing by NABARD, NHAI, IRFC, PFC and REC Ltd., along with issuances of GoI’s

fully-serviced bonds by other companies. The details for the last three years are

provided in

Exhibit 1

(please note that we have not included recapitalization of

public sector banks (PSBs) in the estimation of adjusted fiscal deficit).

For almost two decades

until FY17, off-budget

capital spending was rarely

above 0.5% of GDP, which

increased to 1.0% in FY18

and further to 1.6% of GDP

last year.

Notably, off-budget capital spending for almost two decades until FY17 was rarely

above 0.5% of GDP

(Exhibit 3).

This channel of capital spending, however, accounted

for 1.0% of GDP in FY18 and as much as 1.6% of GDP in FY19.

Capital spending by

the limited set of five agencies increased from an average of one third of reported

capital spending between FY13 and FY17 to almost two thirds in FY18 and about

100% in FY19.

This sort of disproportionate dependence on EBR to finance fiscal

investments raises questions over the need of such off-budget transactions and the

sanctity of the reported deficit numbers.

Exhibit 3:

Total capital spending by the central government including off-budget transactions

(% of GDP)

4.3

3.6

3.0

2.5

0.3

2.2

0.4

0.6

2.1

2.9

3.8

3.5

0.3

1.8

2.1

0.5

1.6

2.4

0.5

Budgeted capital spending

4.0

0.5

2.9

0.5

2.0

0.4

1.6

2.2

0.5

1.7

3.2

2.6

0.6

2.0

2.6

0.8

1.8

2.3

0.6

1.7

2.2

0.6

1.7

2.1

0.5

1.6

2.5

0.6

1.8

2.3

0.5

1.9

2.5

1.0

1.5

1.6

Off-budget capital spending

Total capital spending

2.6

1.6

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19

Source: Union Budget documents, CGA, CAG, Company Annual reports, MOFSL

These estimates also provide an answer to the arguments, which call for additional

capital spending by the government, irrespective of the headline fiscal deficit.

Adjusted estimates suggest that the government has already done that on a

massive scale during the past two years

(Exhibit 3).

The financing for a good

part of these off-budget

capital spending is being

done by the national small

savings funds (NSSF) and

GoI’s fully-serviced bonds.

Moreover, the financing for a good part of these off-budget capital spending is being

done by the national small savings funds (NSSF) and the GoI’s fully serviced bonds.

These two sources accounted for almost the entire (INR722b) off-budget capital

spending in FY17, ~60% (INR965b) in FY18 and 43% (INR1.3t) in FY19. Therefore, it is

important that such off-budget capital spending is incorporated in the estimation of

the fiscal deficit of the central government.

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Conclusion: There is no space for any fiscal stimulus

Adjusted fiscal deficit of

India’s CG stood at 6.3% of

GDP in FY19, much higher

than the RFD of 3.4%.

Overall, the adjusted (or true) fiscal deficit of the central government stood at 6.3%

of GDP in FY19, much higher than the RFD of 3.4%

(Exhibit 4).

CG’s adj. FD increased

from a nine-year low of 4.8% in FY17 to 5.9% in FY18 and further to a six-year high

of 6.3% of GDP in FY19. As discussed above, the outstanding arrears on account of

various subsidies – implying off-budget revenue spending – were at a decade-high

(and the second highest since the late 1990s) of 1.3% of GDP or INR2.5t in FY19.

Further, the off-budget capital spending was 1.6% of GDP (or INR3.0t), more than 3x

the average size of 0.5% of GDP during the two decades up to FY17.

Exhibit 4:

Adjusted fiscal deficit of the central government vis-à-vis reported fiscal deficit

(% of GDP)

6.8

0.8

Reported fiscal deficit

Off-budget tansactions

8.3

6.4

0.7

4.9

0.6

6.0

5.7

4.3

4.4

0.6

3.9

4.9

1.0

4.0

5.0

1.7

3.3

FY07

CG's adjusted fiscal deficit

7.4

1.0

5.9

1.1

7.6

1.7

6.5

1.6

5.9

6.1

1.6

5.5

1.4

4.1

5.3

1.4

3.9

5.4

2.0

3.5

FY18

2.3

3.5

1.0

2.5

FY08

FY09

6.3

2.9

4.8

1.3

3.5

FY17

6.0

6.5

4.8

4.9

4.5

3.4

FY19

FY02

FY03

FY04

FY05

FY06

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Source: Union Budget documents, CGA, CAG, MOFSL

The government’s net

borrowings were >130% of

the household surplus –the

highest at least since the

late-1990s.

The combined adj. FD of the general government (center + states), thus, was at

seven-year high of 8.8% of GDP in FY19, as against the RFD of 5.9%

(Exhibit 5).

According to our

estimates,

household net financial savings (or HH surplus) were

broadly unchanged at ~6.7% of GDP in FY19, implying that the government’s net

borrowings were more than 130% of the household surplus – the highest at least

since the late-1990s.

These facts not only douse any case for a fiscal stimulus but

also explain the ineffectiveness of monetary easing.

Exhibit 6:

…implying that government’s net borrowings

were at record >130% of household surplus last year

HH surplus

(% of GDP)

Combined FD (% of HH surplus, RHS)

129.5

131.0

Exhibit 5:

Adjusted deficit of the combined government was

at a seven-year high of 8.8% of GDP in FY19…

Center

States

Combined FD

10.710.4

(% of GDP)

9.5

8.8

8.5 8.3 8.1

7.9

2.4

7.8

7.8 7.4

7.6 7.6

2.9

1.9

6.8

2.5

2.0 2.2

2.1

2.6 2.3

5.1

2.4

2.8

3.3 2.4 1.8

4.4 4.9 5.0 3.5

FY05

FY07

1.5 8.3

7.4

5.9

7.6

6.5 6.1 5.5

5.3 4.8 5.4 6.3

FY13

FY15

FY17

FY19

FY09

FY11

FY05

FY07

FY09

FY11

FY13

FY15

FY17

FY19

FY19 data for HH surplus (=Net financial savings) is our estimate

Source: CSO, Union Budget, MOFSL

5 November 2019

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NOTES

5 November 2019

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*In

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days take appropriate measures to make the recommendation consistent with the investment rating legend.

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broker-dealer, MOSIPL, and therefore, may not be subject to NASD rule 2711 and NYSE Rule 472 restrictions on communication with a subject company, public appearances and trading

securities held by a research analyst account.

For Singapore:

In Singapore, this report is being distributed by Motilal Oswal Capital Markets Singapore Pte Ltd (“MOCMSPL”) (Co.Reg. NO. 201129401Z) which is a holder of a capital markets services

license and an exempt financial adviser in Singapore,

as per the approved agreement under Paragraph 9 of Third Schedule of Securities and Futures Act (CAP 289) and Paragraph 11 of First Schedule of Financial Advisors Act (CAP 110)

provided to MOCMSPL by Monetary Authority of Singapore. Persons in Singapore should contact MOCMSPL in respect of any matter arising from, or in connection with this

report/publication/communication. This report is distributed solely to persons who qualify as “Institutional Investors”, of which some of whom may consist of "accredited" institutional investors

as defined in section 4A(1) of the Securities and Futures Act, Chapter 289 of Singapore (“the SFA”). Accordingly, if a Singapore person is not or ceases to be such an institutional investor, such

Singapore Person must immediately discontinue any use of this Report and inform MOCMSPL.

Disclaimer:

The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or

distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent. This report and information herein is solely for informational purpose

and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes

investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions

expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific

recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. Each recipient of this document should make such investigations as it deems

necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult its

own advisors to determine the merits and risks of such an investment. The investment discussed or views expressed may not be suitable for all investors. Certain transactions -including those

involving futures, options, another derivative products as well as non-investment grade securities - involve substantial risk and are not suitable for all investors. No representation or warranty,

express or implied, is made as to the accuracy, completeness or fairness of the information and opinions contained in this document. The Disclosures of Interest Statement incorporated in this

document is provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. This information is subject to change without any prior

notice. The Company reserves the right to make modifications and alternations to this statement as may be required from time to time without any prior approval. MOFSL, its associates, their

directors and the employees may from time to time, effect or have effected an own account transaction in, or deal as principal or agent in or for the securities mentioned in this document. They

may perform or seek to perform investment banking or other services for, or solicit investment banking or other business from, any company referred to in this report. Each of these entities

functions as a separate, distinct and independent of each other. The recipient should take this into account before interpreting the document. This report has been prepared on the basis of

information that is already available in publicly accessible media or developed through analysis of MOFSL. The views expressed are those of the analyst, and the Company may or may not

subscribe to all the views expressed therein. This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to

any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of

or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject MOFSL to any

registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in

whose possession this document may come are required to inform themselves of and to observe such restriction. Neither the Firm, not its directors, employees, agents or representatives shall

be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

The person accessing this information specifically agrees to exempt MOFSL or any of its affiliates or employees from, any and all responsibility/liability arising from such misuse and agrees not

to hold MOFSL or any of its affiliates or employees responsible for any such misuse and further agrees to hold MOFSL or any of its affiliates or employees free and harmless from all losses,

costs, damages, expenses that may be suffered by the person accessing this information due to any errors and delays.

Registered Office Address: Motilal Oswal Tower, Rahimtullah Sayani Road, Opposite Parel ST Depot, Prabhadevi, Mumbai-400025; Tel No.: 022 71934200/ 022-71934263; Website

www.motilaloswal.com.

CIN No.: L67190MH2005PLC153397.Correspondence Office Address: Palm Spring Centre, 2nd Floor, Palm Court Complex, New Link Road, Malad(West), Mumbai- 400 064. Tel No: 022

7188 1000.

Registration Nos.: Motilal Oswal Financial Services Limited (MOFSL)*: INZ000158836(BSE/NSE/MCX/NCDEX); CDSL and NSDL: IN-DP-16-2015; Research Analyst: INH000000412. AMFI:

ARN - 146822; Investment Adviser: INA000007100; Insurance Corporate Agent: CA0579 ;PMS:INP000006712. Motilal Oswal Asset Management Company Ltd. (MOAMC): PMS (Registration

No.: INP000000670); PMS and Mutual Funds are offered through MOAMC which is group company of MOFSL. Motilal Oswal Wealth Management Ltd. (MOWML): PMS (Registration No.:

INP000004409) is offered through MOWML, which is a group company of MOFSL. Motilal Oswal Financial Services Limited is a distributor of Mutual Funds, PMS, Fixed Deposit, Bond,

NCDs,Insurance Products and IPOs.Real Estate is offered through Motilal Oswal Real Estate Investment Advisors II Pvt. Ltd. which is a group company of MOFSL. Private Equity is offered

through Motilal Oswal Private Equity Investment Advisors Pvt. Ltd which is a group company of MOFSL. Research & Advisory services is backed by proper research. Please read the Risk

Disclosure Document prescribed by the Stock Exchanges carefully before investing. There is no assurance or guarantee of the returns. Investment in securities market is subject to market risk,

read all the related documents carefully before investing. Details of Compliance Officer: Name: Neeraj Agarwal, Email ID: na@motilaloswal.com, Contact No.:022-71881085.

* MOSL has been amalgamated with Motilal Oswal Financial Services Limited (MOFSL) w.e.f August 21, 2018 pursuant to order dated July 30, 2018 issued by Hon'ble National Company Law

Tribunal, Mumbai Bench.

5 November 2019

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