No.s 39 & 40, June 2005

No.s 39 & 40
(June 2005):

Examining the Current Boom

Budget 2005-06:
IV. Declining Productive Expenditure

According to the argument plugged by the World Bank and economists of its line of thinking, the State should exit a whole range of economic activities: not only manufacturing but even infrastructure (power, roads, telecommunications, airlines and airports, ports, and even railways). These, they say, should instead be carried out by the private sector. The money the State would supposedly save through exiting these activities could be spent to provide better health, education, and other services for the “truly poor”. Thus the World Bank presents slashing of productive expenditures and a programme of privatisation not as a way of opening up profitable activities to foreign investment, but as concern for the poor. Precisely this formula has been adopted by the UPA government: liberalisation, globalisation and privatisation “with a human face”. As evidence of its bona fides, it can point to its increased social services allocations.

If production and employment were growing healthily, increased expenditures on health and education would no doubt yield greater well-being. But when people’s livelihoods decline, increased spending on health and education cannot make up for that basic gap. Indeed total social services expenditure of the Centre and the states has not fallen as a percentage of GDP in the period of liberalisation (while certain heads of expenditure have declined within that, others have risen). What has fallen very sharply is expenditure on productive activity. In the case of the states, it is the category “economic services” that has declined, not social services. We have already looked at the example of spending on the agricultural sector, on which the bulk of the population depends for its livelihood. The same retrenchment is visible in overall spending on productive activity.

Total budgetary expenditure is divided into two categories, Plan and non-Plan expenditure. Plan spending is largely developmental spending on agriculture, rural development, irrigation, energy, industry and minerals, transport and roads, communications, science and technology, environment, and social services. Non-Plan expenditure is for non-developmental activities such as interest payments and debt servicing, the military, subsidies, pensions, police and other organs of the State.

Plan expenditure is itself divided into two categories, revenue expenditure and capital expenditure. The former signifies running costs, such as salaries, which while necessary create no lasting assets. The only category which creates lasting productive assets is Plan capital expenditure. (Non-Plan capital expenditure too creates lasting assets, but of a non-productive type; most of it consists of weapons for the military. This last is not merely unproductive, but a drain from the economy, as most of it is spent on imports.)

Even before liberalisation began, 85 per cent of the Union Budget was spent on heads that created no lasting productive assets: Plan capital expenditure was just 15 per cent of total expenditure. The budget-slashing economic policies adopted since 1991 reduced the latter figure to 9.4 per cent of expenditure by 2004-05.

As a percentage of GDP, the fall was steeper: from 2.77 per cent of GDP in 1990-91, Plan capital expenditure reached 1.53 per cent of GDP in 2004-05 (see Chart 1).

A third way to look at it is to measure its growth in real terms (that is, after discounting for inflation). In real terms, Plan capital expenditure crawled upward between 1990-91 and 2002-03 at the compound annual rate of just 1.9 per cent.

States left to the mercy of the market
In the 2005-06 Budget, a major step has been taken by the Centre, with far-reaching consequences. Till now, the Centre used to extend loans to the state governments for their Plan expenditures. However, the Centre used to charge excessive rates of interest on these loans, much higher than the rates at which it itself borrowed (see Aspects no. 38, pp 47-55). This practice naturally came in for criticism. Instead of reducing the interest rates to a level which the states could sustain (one proposal was for the rate to be just below the state’s rate of GDP growth), and compensate for earlier excessive charges, the UPA government has seized on a recommendation of the Twelfth Finance Commission and discontinued the practice of extending loans to the states. Hereafter states will have to raise loans for their Plans on the market.

There has been no clarification as to how states will raise these loans. If they have to do so in their individual names, and without any backing from the Centre, they may fail to raise the targeted amount (of Rs 290 billion in 2005-06). Indeed the secretary, Department of Economic Affairs, Rakesh Mohan, has said that borrowings by the states may well fall short of the Budget estimate. (Economic Times, 8/3/05)

While most of the states are in a fiscal crisis, including supposedly developed ones like Maharashtra, it is particularly unlikely that backward states such as Bihar will be able to raise funds from the market. Companies are “rated” by credit rating agencies on their financial soundness, and those with low ratings pay higher interest rates or are unable to borrow at all; the same process might occur with states.1

Into the hands of external agencies

Two things may follow. First, some states could merely reduce their Plan spending, as a result of which existing regional inequalities would deepen, which also would mean that poverty would deepen. Secondly, unsuccessful at the market, states could turn to outside agencies such as the World Bank and Asian Development Bank for loans. Such external agencies would take control of the state government’s budget and economic policies as the price of the loan. The devastating consequences of such a takeover by the World Bank and the U.K.’s Department for International Development (DFID) have already been seen most strikingly in the case of Andhra Pradesh in the form of increased poverty and peasant suicides.

An idea of what is to come with increased World Bank control over state government finances can be seen in the following news report. As the price of a loan to Maharashtra, the World Bank ordered the passage of two legislations with profound consequences for the state’s peasantry; the state government did its bidding with haste:

Ever since the Maharashtra government moved a proposal for financial assistance (of Rs 17 billion for completing 257 irrigation projects in the state), World Bank officials insisted that they were prepared to consider the proposal only if the state government sets up a regulatory authority to regulate water resources.... Secondly, the Bank asked the government to fix water tariff for agriculture, industrial and drinking purposes. Thirdly, it asked the government to come out with a law to provide for management of irrigation systems by farmers.

Taking note of the World Bank observations, irrigation minister Ajit Pawar acted quickly and ensured that the legislations were swiftly passed in both houses of the state legislature.2 The main task of the Water Regulatory Authority will be to establish a water tariff system.... This should be based on the principle that water charges should reflect the full recovery of the cost of irrigation management, administration, operation and maintenance of water resources projects.

Under the Management of Irrigation Systems by Farmers Act, it is compulsory to form a society of water users. 'The main purpose of both the legislations is that the irrigation department should get maximum revenue from release of water from irrigation projects,' the irrigation official said... —Times of India, 24/5/05

This is in a state where just 17 per cent of the cropped area is irrigated (compared to 41 per cent nationwide); in which agricultural output (not just the rate of growth, but the absolute figure) has fallen sharply over the last decade, largely thanks to lack of water; where every year thousands of villages have to be supplied drinking water by tanker. The state’s irrigation potential, according to the Maharashtra Water and Irrigation Commission, can be increased to 12.6 million hectares; actual utilisation of irrigation potential in 2003-04 was 1.6 million hectares. Yet the government is not planning to invest in rapid expansion of irrigation and thus to maximise agricultural output – and the state’s entire economy thereby. Rather, it has enshrined the principle of maximising revenue for the irrigation department! Of course, the ultimate beneficiary is not even to be the irrigation department. All this is merely groundwork for the privatisation of water. Once the state government sets the legal framework for making sale of water a profit-making activity, private parties will be invited to take over the irrigation infrastructure. And that will ring the death knell for the state’s peasantry. (See also “Loan as lever”, Parvathi Menon, Frontline, 19/11/04, for an account of how the World Bank took over control of Karnataka’s economic policy for just $1 billion, with devastating consequences for the state’s peasants and workers.)

Because the Centre’s loans to the states were earlier part of the Plan capital expenditure, the discontinuing of such loans means that Plan capital expenditure for 2005-06 shows a steep drop, to 5.3 per cent of the Centre’s total expenditure. That is, only 5.3 per cent of the Union Budget will create assets which will bring in revenue in future to the Centre. This is by far an all-time low; the earlier low, achieved in 2003-04, was 9.3 per cent.

In terms of GDP, Plan capital expenditure will drop in 2005-06 to just 0.79 per cent, also a new low (see Chart 1).

No doubt, to the extent states succeed in borrowing directly from the market on reasonable terms, the effect on the economy would be the same as if the Centre had borrowed it and lent it to the states. Hence, if we assume that the entire borrowing of Rs 290 billion (targeted for the states) is carried out, the impact on the economy would be as if the Centre had incurred Plan capital expenditure of 1.61 per cent of GDP. Yet even this is far below the level of 1990-91, or even of 1993-94 (see Chart 1).

Moreover, to repeat what we have said above, it is unlikely that states will raise the full Rs 290 billion. In which case the Plan capital expenditure plus states’ borrowings for the Plan may fall much below 1.61 per cent of GDP.3

Announcing 'provisions' for the states – for which the states are to raise the funds
One final note regarding the stopping of Centre’s loans to the states for their Plans: This allows the Centre to announce a scheme to be implemented by the states, without providing either a grant or a loan for it. For example, in his Budget speech, Chidambaram claimed impressively that he was increasing the provision for the Accelerated Irrigation Benefit Programme from Rs 28 billion in 2004-05 to Rs 48 billion in 2005-06. However, it turns out that the budgetary provision for this is zero, and the entire sum of Rs 48 billion has to be raised by the states from the market! There are several examples of other schemes where the Centre’s grant is very low compared to the amount to be raised by the states (see Table 12).

Table 12: Central Assistance: Central Grant vs Amount to Be Raised by States, 2005-06 (Rs bn)

Loan to be raised by states from the market
Additional Central Assistance for Externally Aided Projects
Accelerated Irrigation Benefit Programme
Accelerated Power Development
Urban Renewal Sub-mission for Slum Development
Urban Renewal Sub-mission for Urban Infrastructure & Transport

SOURCE: Union Budget, 2005-06



1.The Twelfth Finance Commission has recommended that the Centre should discontinue loans to the states and allow them to raise loans from the market; but it has also said that if some fiscally weak states are unable to raise funds from the market, the Centre could borrow for the purpose of on-lending to such states, at rates aligned with the Centre’s cost of additional borrowing. The Centre, while accepting this recommendation in principle, mentioned that “From 2005-06, the states would be allowed at their discretion, not to draw the loan portion of the Central Plan Assistance” – suggesting that, if they wished, they could draw the loan portion. (“Report of the Twelfth Finance Commission: A Summary”, RBI Bulletin, March 2005) However, the 2005-06 Budget makes no provision for states to do this, and merely says that “Loans to the extent of Rs 290 billion will be raised directly by State and Union Territory Governments for financing their Annual Plans.” (back)

2. The Water Resources Regulatory Authority Bill was rushed through without reading (let alone debate) by voice vote in the state assembly on the last day of the session, along with 15 other bills. (“Water: How the deal was done”, P. Sainath, The Hindu, 21/4/05) (back)

3. It is also possible that when the states are unable to raise the required sum from the market, there will be pressure on the Centre to loan them the remainder, at least this year, it being a transitional period. However, in following years such loans from the Centre will not be forthcoming. (back)


NEXT: "Infrastructure": for Whom?


All material © copyright 2005 by Research Unit for Political Economy