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All you need to know about off-budget borrowing

ICICIdirect 8 Mins 23 Oct 2023

The Indian government, during the budget session, presents the budget and tells where it will spend the money in the financial year. It happens at both the centre and the state level. Let us say that the government decides that the total amount it will spend is Rs 10 lakh crore (for understanding), and then it hopes that it will be able to receive the same amount in the form of direct and indirect taxes.

However, that is not always the case. The government has to borrow additional money. One way is to borrow from the central banks. The other way is to issue bonds and raise funds through them. The final option with the government is off-budget borrowing. In this article, we are going to talk about it in detail.

What is off-budget borrowing?

Off-budget borrowing refers to a government's practice of raising funds for various purposes without reflecting these expenditures in the official budget. When the government borrows through the central bank or issues bonds, the loan goes into the books. This is reflected in the fiscal deficit. In off-budget borrowing, the loan does not add to the fiscal deficit.

It involves using alternative financing mechanisms to meet specific objectives or to keep certain expenses off the books, thus not showing the full extent of government liabilities in the budget documents. Off-budget borrowing can be a complex and controversial practice, and its impact on the fiscal health of a nation has garnered significant attention.

Reasons why the government goes for off-budget borrowing

Let us look at some of the reasons why the government goes for off-budget borrowing:

  • Meeting Short-Term Objectives: Sometimes, the government needs to fund short-term expenses not reflected in the official budget, such as pre-election expenditures or unforeseen emergencies. Off-budget borrowing allows them to access funds without altering the fiscal deficit targets.
  • Reducing Fiscal Deficit: To maintain fiscal discipline and meet deficit targets, governments may use off-budget mechanisms. By keeping certain expenses off the books, they can report a lower fiscal deficit, which can be politically advantageous.
  • Encouraging Investments: The government might want to encourage private investment in certain sectors without burdening the official budget. Off-budget financing mechanisms can be used to attract investments by offering tax incentives or other benefits. 

How does the government do off-budget borrowing?

Here are some ways in which the government goes off-budget with borrowing:

  • Public Sector Undertakings (PSUs): State-owned enterprises, or PSUs, can borrow on behalf of the government for specific projects or purposes. This debt is not directly part of the central government's budget.
  • Special Purpose Vehicles (SPVs): The government can set up SPVs to raise funds for specific projects or purposes. These SPVs might borrow from the market, and their debt does not directly affect the official budget.
  • Small Savings and National Small Savings Fund (NSSF): The government may raise funds from small savings schemes such as the Public Provident Fund (PPF), National Savings Certificate (NSC), and the NSSF. While these funds are technically part of the budget, they are accounted for differently, making it challenging to assess their impact on the fiscal deficit.

Why off-budget might not be the best thing to do?

Off-budget borrowing might not be the best option for the government to raise funds for the following reasons:

  • Lack of Transparency: Off-budget borrowing can cover the true financial health of the government. It makes it challenging for policymakers, investors, and the public to accurately assess the government's fiscal position.
  • Risk of Fiscal Profligacy: Governments might misuse off-budget mechanisms to overspend or undertake projects without proper evaluation, as these expenses are not as scrutinized as those in the official budget.
  • Legacy Issues: Borrowings from PSUs and small savings schemes can lead to legacy issues where the government is burdened with repayment obligations that were undertaken in the past.

The Numbers & Solution: Off-budget Borrowing

The rule: States are supposed to borrow a maximum of 3.5% of their respective state GDP and an additional 0.5% if they implement mandated power sector reforms.

In 2021, the five states—Andhra Pradesh, Kerala, Karnataka, Telangana, and Tamil Nadu—together accounted for Rs 2.34 lakh crore worth of debt, approximately 93% of the combined states’ liabilities (off-budget). In terms of the highest off-budget liability, Telangana is the highest borrower, with around Rs 97,940.45 crore at the end of 2021, equal to 9.99% of the gross state domestic product (GSDP).

The centre has asked the states to clean up their books by FY26. The state governments have raised concerns about it. Therefore, the government has increased the deadline by one more year until FY27. By FY27, all states should bring their 'off-budget' borrowing within the annual budget by repaying all loans.

The states have already started working on it. In FY22, the total off-budget borrowing stood at 67,000 crore. It was reduced to Rs 18,500 in FY23. Even the centre is working on cleaning its book, as last year it paid off all the off-budget loans it took through the Food Corporation of India (FCI).

Before you go

Off-budget borrowing offers flexibility to the government in managing finances, but it also raises concerns about transparency and the risk of fiscal profligacy. The government needs to strike a balance between meeting fiscal targets and ensuring financial transparency, which is crucial for sound fiscal management in India. Periodic reporting of off-budget borrowings and their impact on fiscal indicators is essential for transparency and accountability in India.

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