Reading a State Budget: Deficit, Debt and the Golden Rule
The finance minister of a state presents a budget with revenue receipts of ₹1,20,000 crore (tax and non-tax) and revenue expenditure of ₹1,45,000 crore, which includes ₹25,000 crore of interest payments. Capital expenditure - roads, bridges and irrigation - is budgeted at ₹40,000 crore. The state's GSDP is ₹10,00,000 crore. In the debate the opposition says the government is 'living beyond its means and eating the future of the next generation', while the minister replies that borrowing for roads is different from borrowing to pay salaries. A newspaper editorial points out that the fiscal deficit works out to 6.5 per cent of GSDP against the 3 per cent FRBM target, and that the state must pay ₹25,000 crore of interest next year before it can repair a single road.
1. Calculate the revenue deficit, the fiscal deficit and the primary deficit, and express the fiscal and revenue deficits as percentages of GSDP.
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| Deficit | Formula | Calculation | Value |
|---|---|---|---|
| Revenue deficit | Revenue expenditure − revenue receipts | 1,45,000 − 1,20,000 | ₹25,000 crore |
| Fiscal deficit | Total expenditure − revenue receipts (borrowings excluded) | (1,45,000 + 40,000) − 1,20,000 | ₹65,000 crore |
| - check | Revenue deficit + capital expenditure | 25,000 + 40,000 | ₹65,000 crore ✓ |
| Primary deficit | Fiscal deficit − interest payments | 65,000 − 25,000 | ₹40,000 crore |
As ratios to GSDP (₹10,00,000 crore)
- Fiscal deficit = 65,000 ÷ 10,00,000 = 6.5% - more than twice the 3% FRBM target.
- Revenue deficit = 25,000 ÷ 10,00,000 = 2.5%.
- Interest payments = 25,000 ÷ 1,20,000 = 20.8% of revenue receipts, i.e. more than a fifth of all revenue is consumed before any salary, subsidy or service is paid.
The primary deficit of ₹40,000 crore is the borrowing required for this year's activity alone, ignoring the burden of past borrowing.
2. Assess the minister's claim that 'borrowing for roads is different from borrowing to pay salaries'. Which side of the argument does the budget data support?
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The principle behind the minister's claim - the golden rule. Borrowing is defensible when it finances capital expenditure that creates an asset and adds to future output and tax revenue; the project should earn a return higher than the interest cost. Borrowing to finance revenue expenditure - salaries, subsidies, interest - creates no asset, adds nothing to future income, and leaves a recurring liability. On this principle the minister is right in theory.
What the data show, however
- Of ₹65,000 crore of borrowing, only ₹40,000 crore (about 61.5%) finances capital expenditure.
- ₹25,000 crore finances the revenue deficit and is largely interest on past borrowing - that is, borrowing to pay for past consumption.
- So the revenue account is not in surplus; the state is borrowing both for roads and to keep the current account running. Interest alone takes 20.8% of revenue receipts.
Verdict: the opposition is partly right. The state is not simply 'borrowing for roads'. The presence of a revenue deficit of ₹25,000 crore means current consumption is being charged to the future. A large and rising interest burden also risks a debt trap - more borrowing to pay interest - and can crowd out private investment by absorbing household savings. Equally, the minister is right that slashing capex to hit the 3% target would be a false economy: the FRBM framework itself permits borrowing for capital spending, and the sustainable target is a revenue deficit of zero with capex protected.
3. Suggest two fiscal measures the state could take to reduce its revenue deficit, and state one risk attached to each.
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Measure 1 - widen the tax base rather than raise rates. Bring urban property under a properly assessed property tax, strengthen professional tax and electricity duty collection, and improve GST compliance through invoice matching. The revenue base grows without a headline rate increase that would discourage activity. Risk: administrative cost and weak municipal capacity; assessment and collection may cost more than they yield in the first years, and evasion may simply shift to other channels.
Measure 2 - prune untargeted subsidies. Free or heavily subsidised power to well-off farmers, and untargeted food and transport subsidies, are revenue expenditure with no asset behind them. Replace them with direct benefit transfers to identified beneficiaries. Risk: political resistance, and exclusion errors that deny support to genuinely poor households - a saving on paper can become a welfare loss, and the credibility of future reform suffers.
A third possibility, with its own risk: raise user charges for water and municipal services to cover their cost. Risk: cost-push pressure on household budgets and a regressive burden on the poor, unless a lifeline slab is retained.
The state should protect capital expenditure while doing this: cutting roads to reduce the deficit would satisfy the arithmetic and damage the growth that ultimately services the debt. A credible path is to phase the revenue deficit to zero over three to four years, publishing the interest-to-revenue ratio each year.