• This article looks ahead. Voters will be happy with Freebies but forget cost is to be borne by them though indirectly. Overspending in the 1980s was one of the reasons for the 1991 crisis? What caused the economic crisis then? If Universal Basic Income is implemented will India face another crisis? 

A few days ago I woke up to a full page advertisement issued by the Congress government of Rajasthan. It announced a Minimum Guaranteed Income Scheme of 125 days under IG Urban Employment Guarantee Scheme in addition to 125 days under NREGA (rural) plus a Social Security Pension 1000/ per month that would increase by 15% p.a. Earlier it announced free electricity up to 100 units, free mobile phones for women and free emergency healthcare etc. Rs 40,000 crs is what Congress promises in Chhattisgarh may add up to

Some say one of the reasons why the Congress won Karnataka was because of the five guarantees namely 200 units of free power to all households (Gruha Jyoti), Rs 2,000 monthly assistance to the woman head of every family (Gruha Lakshmi), 10 kg of free rice to every member of a BPL household (Anna Bhagya), Rs 3,000 every month for unemployed graduates and Rs 1,500 for unemployed diploma holders, both in the age group of 18-25 (YuvaNidhi), and free travel for women in public transport buses (Shakti). Estimated cost of guarantees is Rs 50,000 crores.

Not wanting to be left behind and being aware of the Congress template of guarantees S S Chouhan, the BJP CM of Madhya Pradesh announced the Ladli Behna Scheme that gives women, who qualify, Rs 1,000/ per month. Besides that he also announced payment of Rs 6,000/ p.a. to farmers. This is in addition to what they will receive under PM Kisan Yojana. Total cost of this and other schemes app Rs 20,000/ per annum. PM Modi recently spoke about spending Rs 25,000 crs in tribal dominated districts (details are not known)

And these are not the only states. AAP Delhi started the trend. Read  Decoding Delhi’s Budget – Why its freebie model cannot be replicated

How would freebies impact the fiscal deficit?

The Finance Commission had recommended a fiscal deficit limit of 3% of State Gross Domestic Product during FY24 with an additional .5% available for power sector reforms. If the fiscal deficit (FD) falls within this limit even after freebies it should be fine.

However, to keep FD within limits states could cut down capital expenditure as Karnataka has proposed in FY24 budget. Capex is Rs 54,374 crore, which is 11.2 per cent lower than the Rs 61,234 crore that was proposed in Bommai’s budget. Source  OR  reduce development expenditure. Karnataka government cannot provide development this year says Deputy CM Shivakumar 

In November 2023, Punjab decided to levy a registration fee of .25% on vehicle and home loans given by banks. Source Nothing comes free, subsidies lead to higher indirect taxation. 

Capex creates assets that give long-term benefit, generate demand for core sectors, create jobs and increase growth whilst freebies i.e. revenue expenditure is used in the present. Moreover, once given freebies say free power/pension, are difficult to stop.  

“Read  Multiplier effect of more expressways And  Why the Zojila tunnel shall revolutionize connectivity to Ladakh And  Nagaland gets its first medical college after 60 years of statehood

This NDA government is using capex, instead of stimulus, to stimulate growth. Capex as a share of Budget expenditure was 14.1% in 2016, up to 22.2% in FY 24. Hindustan Times 2/2/2023.

Introduced by the Akali Dal-BJP government in 1998-99, estimated annual cost of free power this year is atleast Rs 7,500 crores. If the power subsidy is funded by the state government it is ok but most governments are strapped for cash due to salaries/pension bills and increasing demands so transfers to dishcoms get delayed. This has resulted in deterioration in their financial condition. Eventually, power supply suffers, people complain.

Farmer Subsidy ensures the vicious cycle of distress continues leaving States with lesser resources for investment in agriculture R&D and water management, benefits of which shall accrue to farmers in the long-term. 

What constitutes a freebie is beyond the scope of this article.

Two, to fund the freebies, states increase VAT on petroleum products or tax on real estate. Himachal Pradesh increased VAT on diesel by Rs 6/ in 2023. People crib about high fuel prices without realizing that freebies have to be funded. Statutory levies on farm products contribute to final cost.

Increase in retail price of fuel results in a higher inflation rate that might force the RBI to increase interest rates affecting borrowers adversely.

So also, to fund freebies the newly elected Karnataka government announced a 20% hike in existing rates of additional excise duty on Indian Made Foreign Liquor and has decided to revise the guidance values for all immovable properties across the state this year. This increases cost to the consumer.

There would be many freebies given over the years. The cost of funding them is borne by us in ways that we cannot visualize because there is no one to one correlation. Before or after GST taxing petroleum products and liquor are well-known revenue raising tools.   

Three, such revenue expenditure (excluding genuine welfare schemes) reduces people’s motivation to work harder and improve their lives. Instead it makes people dependant on the state.

Politicians love giving doles-makes them control your life and perhaps vote.

If all states give such freebies and the state fiscal deficit of 3% is crossed it shall increase inflation i.e. eventually borne by the common man. Simply put, inflation is more money chasing fewer goods. NOTHING COMES FREE.

After the Congress won Himachal elections, chief minister S S Sukhu promised Minimum Support Price for milk. “We will streamline milk procurement, offer to buy 10 litres from every family, set up chilling plants and resell the milk in the market at a subsidy: we will recover costs by levying a cess on the sale of liquor.” (Business Standard 12 December 2022). Such cross-subsidization builds inefficiencies.

Before knowing about Centre spends look at U.S. $1.9 trillion Rescue Plan 2021.

One of the four plan categories was direct aid to families ($600 billion) that included $ 1400 per person rebate. There were certain income limits so payments should go to about 159 million households.

Inflation hit a 40 year high of 9.1% in June 2022. Note that highest inflation rate between 2015 and 2020 was 2.30%.

Rebate, probably, got used up combating high inflation.

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One of the reasons for high inflation during UPA 2 was more money (fiscal stimulus) chasing fewer goods.

Now take the Centre. 

1. The UPA government introduced two welfare schemes. One, is the National Food Security Act (NFSA) in 2013 and two, NREGA (an unemployment scheme) in 2005. The former has an outlay of atleast Rs 1 lakh crores and the second atleast Rs 60,000 crores p.a. NDA2 started Kisan Yojna in 2019, estimated outlay atleast Rs 60,000 crores p.a. 

NREGA was helpful during Covid19. But surely, none visualized of Covid in 2005. Think how many schools, hospitals, food processing funds could be made with NREGA funds.

UPA was lucky because NDA2 had to find the money for NFSA. Initially, it used a Congress approach that is got the Food Corporation of India to fund (see Table). Later, better sense prevailed. It funded NFSA from the budget. State leaders are never tired of saying agriculture is a state subject but none objected to the Rs 6,000/ farmer dole.

Table1 - Subsidy incurred by Food Corporation of India, 2011-12 to 2019-20 

Source - http://fci.gov.in/finances.php?view=22 *Food subsidy bill per Budget July 2019.

Where will the money come from is a question rarely asked in India. 

Read  Ideas to clear the Food Corporation of India mess  

Thanks to NFSA, the NDA government is providing free food grains about 81 crore beneficiaries, estimated cost atleast Rs 1.75 lakh crores. Surely, this helped during the pandemic but Covid19 in 2020 was not dreamt of when NFSA bill was passed in 2013.

Read  Centre must review list of 81 crore NFSA beneficiaries

2. Successive governments have not increased end consumer prices when crude prices went up for e.g. UPA. “Instead of paying direct subsidy to oil marketing companies from the Budget, the then government issued oil bonds totalling Rs 1.34 lakh crore to the state-fuel retailers in a bid to contain the fiscal deficit.” Source Interest cost from 2016-17 to 2020-21 was app Rs 10,000 crs p.a.

Read  Oil Bonds-why and how much

If price increase is not due to an increase in crude prices it must be called out. Otherwise, do we realize the impact of undercharging? Consumer has to pay today or tomorrow.

Some Numbers

Union government’s expenditure on subsidies was Rs 196, 769 cr in 2019-20, Rs 446,150 cr in 2021-22 (Covid) and Rs 374, 707 cr in FY24 BE. Fertiliser subsidy was Rs 70,605 cr in 2019-20 and Rs 175,100 cr in BE. Hindustan Times 2/2/2023.

One can argue that the increase in spends are because of the Ukraine War. Note that events over which we have no control shall keep happening.  

Now let us look at some key fiscal numbers from 1980 to 2023.

T2 - Gross Fiscal Deficit as a % of GDP/Import Cover in Months/Inflation % 

Source Reserve Bank of India - GFD, Import Cover , Consumer Price Index

Here are some observations from table:

The fiscal deficit, import cover and inflation percentages began to head southwards in 1986-87 and became a crisis in 1990-91. Inflation in 2009-10 was at a high of 12.2% meaning more money chasing fewer goods. Ditto in 2012-13 when balance of payment came under stress with import cover being (meaning foreign exchange reserves) equivalent of seven months imports.

Macroeconomic stability 

One of the reasons things are looking better today is macroeconomic stability on various fronts including improved current account deficit, robust banks and easing inflation pressure. Fortune India

If one compares current situation with UPA2, macro-instability was then caused by fiscal expansion, high crude and food support prices, 2013 run on the rupee, phone banking, banking sector problems and over-leveraging etc.

Impact of Universal Basic Income (UBI)

After having tasted blood with guarantees in Karnataka, the Congress might Minimum Income in 2024. The 2019 Congress Manifesto referred to NYAY, as a joint scheme of the Central and State governments. It would target 5 crore poorest families. Each family would be given an assured cash transfer of Rs 72,000/ p.a.  

According to a 2019 Times of India report, “A minimum guaranteed income to one member each of the country, each of the country’s 25% poorest households could cost Rs 7 lakh crs p.a.” Another 2019 MINT report states “Providing all individuals with a poverty line-equivalent universal basic income (Rs 1,180 per month for each individual, in 2017-18 prices) would cost around ₹ 19 trillion.”

If such a scheme is to be feasible it will require doing away with existing subsidies and schemes like NREGA/fertilizer subsidy, which no political party is likely to do. On subsidy, most Indians say, ‘Yeh Dil Mange More’.

UBI shall encourage illegal immigration from Bangladesh, Pakistan and Myanmar.  

To these costs add need for higher defence expenditure due to the ever-increasing China threat and move by some state governments to revert to the old pension bill. I am not even referring to the burgeoning salaries bill and impact of OROP (one rank one pension) or another oil price shock.

Since these would have disastrous consequences for India’s economy it might be useful to recall what caused the 1991 Financial Crisis. A Coalition government at the Centre will only increase the pulls and pressures.

Cause of 1991 Economic Crisis

Here are reasons, based on conversation with a senior economist. Reason 5 has excerpts from Dr Singh’s 1991 speech.

1. The immediate trigger was Iraq’s invasion of Kuwait and the spike in crude prices. It caused a balance of payment crisis. Those days deposits from Non-resident Indians and remittances helped fund the trade deficit. NRIs pulled out in light of the war. Then there were no Foreign Portfolio Investors and Foreign Direct Investment was minimal. Foreign Commercial Borrowings fell too.  

2. All through the 1980s there was a fiscal expansion spree. There was lots of foreign borrowing by government and public sector.  

3. India ran a massive fiscal deficit and increasing foreign debt. It was a deeper problem of the economic model being followed then. 

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4. “A fiscal deficit of 8 per cent of gross domestic product (GDP) and a current account deficit of 2.5 per cent of GDP all added to the government’s woes. Double-digit inflation numbers also added to the burden of the common man.” Source ThePrint

5. Excerpts from Dr MM Singh budget speech of 1991, “The origins of the problem are directly traceable to large and persistent macro-economic imbalances and the low productivity of investment, in particular the poor rates of return on past investments. There has been an unsustainable increase in Government expenditure.

During the fiscal year ending 31st March 1991 the wholesale price index registered an increase of 12.1 per cent, while the consumer price index registered an increase of 13.6 per cent.” End of Quote. 

Key words relevant today and in 1991 are, “Raising productivity, improving efficiency and reducing costs.”

It is difficult to predict how people would reach to UBI. Suppose, people say we do not want to work there would be a supply side shock to the economy.

Buoyant GST revenues today cannot be the basis for introducing UBI. Revenues will not keep rising and is linked to the economy. 

The impact of five years of over-spending might be significantly felt only by the government that assumes office in 2029.   

Look before making promises to voters. Learn from history. Reduce oil imports. Utmost care was taken in collection of data. Errors if any are unintended and without malafide intent. This article should be republished without written permission of www.esamskriti.com

Author is a Chartered Accountant, not an Economist.

To read reasons for 1991 crisis in detail, see below. 

The post 1990’s generation might find it difficult to visualize the situation in 1991, hence sharing extracts from a detailed and very good piece by Ankit Mittal in the MINT titled, The Long road to the 1991 Economic Crisis Here are excerpts –

1. “The 1979 budget was a turning point from the relative conservatism of previous fiscal management.

2. In 1979 India suffered the worst drought since Independence and the global oil shock (caused by the Islamic Revolution in Iran).

3. This increased cost of borrowing, interest burden and a scaling back of public investment resulted.

4. Rapid monetary expansion and political instability followed when the Janata Party coalition broke.

5. The current account deficit deteriorated from 4% (1978-79) of exports to 31% (1981-82).

6. To fund an increase in investments the government approached the International Monetary Fund in 1980.

7. Post negotiation of the IMF deal, The FD of the consolidated government, which had averaged 4.75% of GDP in the decade before 1979, averaged 9% in the decade after-the average masks the deterioration of the Rajiv Gandhi years (1985-89), when it averaged 10.

8. The deficit was financed by a combination of external borrowings from the IMF, the World Bank and commercial sources, as well as the crowding out of the private sector—higher bank reserve requirements to forcibly accommodate government borrowing needs reduced credit availability for the private sector—and deficit monetization (essentially money printing by the RBI).

9. Therefore, the root of the balance of payment crisis lay in, first, the investment-savings deficit driven by fiscal profligacy; second, the reliance on non-concessional external borrowing to fund that deficit; and finally, the inability of export growth to keep pace with the growth in import.

10. Manmohan Singh (governor for 1982-85) and R.N Malhotra (1985-90) from time to time raised concerns over the rapid growth in monetary base due to government spending, the resultant threat to price stability, rising external deficits and the crowding out of credit to the private sector. These warnings fell on deaf ears as the finance ministry emphasized the urgent developmental and defence needs of the country.

11. The fact that by the time Manmohan Singh rose to present the budget in the summer of 1991 he was the seventh finance minister in six years did not help matters.

12. However, price rise had been kept in check by savage monetary measures that made credit inaccessible for everyone except the government and by keeping administered prices low—almost a third of the components of the wholesale price index basket were either fully administered, partially administered or subjected to different forms of voluntary and other mechanisms.

13. I.G. Patel, RBI governor from 1977 to 1982, describing the official reaction in a famous speech (https://www.jstor.org/stable/41498726), noted that “It was already clear by 1986 that we were in an internal debt trap which would soon engulf us in an external debt trap. Rather than take any remedial action, we went merrily along, borrowing more and more at home and on shorter and shorter terms abroad.”