Using accounting devices to hide fiscal deficits – a framework

Timothy Irwin of IMF has this excellent readable paper on fiscal math.  Both fiscal and monetary math and accounting is challenging to say the least.

Irwin says using these accounting devices, govt hides figures and creates fiscal illusion that all is well:

A government seeking to reduce its deficit can be tempted to replace genuine spending cuts or tax increases with accounting devices that give the illusion of change without its substance, or that make the change appear larger than it actually is. Under ideal accounting standards, this would not be possible, but in real accounting it sometimes is. For example, governments can sometimes sell assets or borrow money and count the proceeds as revenue, or defer unavoidable spending without recognizing a liability. In each case, this year’s reported deficit is reduced, but only at the expense of future deficits. The result is that the reported deficit loses some of its accuracy as a fiscal indicator. 

The use of accounting stratagems cannot be eliminated, but several things can be done to reduce their use or at least bring them quickly to light. Governments can be encouraged to prepare audited financial statements—income statement, cash-flow statement, and balance sheet—according to international accounting standards, and statisticians, who in many countries use accounting data to compile the most important (“headline”) fiscal indicators, can be given the resources and independence to be both expert and impartial, as well as the authority to revise standards in the light of emerging problems.

To help reveal remaining problems in headline fiscal indicators, a variety of alternative fiscal indicators can be monitored, since a problem suppressed in one fiscal indicator is likely to show up in another.  Many of the devices documented in this note would be revealed if governments also reported change in net worth and high-quality long-term forecasts of the headline indicator of the deficit under current policy.

He mentions fours such a/c devices in a nice 2*2 matrix :

  • hidden borrowing: Leads to more revenue now but more spending later
  • disinvestment: Leads to more revenue now but less  revenue later
  • deferred spending: leads to less spending now but more spending later
  • foregone investment: Leads to less spending now but less revenue later

He goes on to give some excellent examples  on how diff. countries retort to these devices to hide deficits.

Here is  authors’ post on the  paper and interview of the  author.

A very good read.

What about India?

  • Disinvestment: Teh author says some disinvestment is good as govt. wants to get out of these businesses. However, if it is just to show better fiscal numbers then there is trouble. Now, there is nothing to suggest that Indian govt is selling these to get out of business. It is mostly to show better fiscal numbers. This year, the 40,000 cr disinv target  not met and fiscal deficit shot up (also on account of higher subsidies and lower revenues)
  • Showing lesser subsidies: This has been a problem for last couple of years. This is  nothing but an example of deferred spending. Underbudgeted subsidies lead to lower spending now and higher later.
  • Oil Bonds: Before 2008 crisis, govt. issued oil bonds to keep oil subsidies lower and pay oil companies for under-recoveries. The idea was soon extended to fertilizer and food companies (govt. companies) as well. The govt. kept these oil bonds out of its books and reported lower fiscal deficits. This was nothing but a form of hidden borrowing.
  • Even the effective revenue deficit is an interesting way to show lower revenue deficits.

Now, these are commonly known ones. Am sure, there will be many others which requires a very careful analysis of Budget. Unfortunately, we hardly have people who dissect the budget threadbare as seen in other developed economies. Most analysis centres on the above mentioned items.

India needs an independent fiscal watchdog at the earliest. Going by how frequently the fiscal targets are missed and by big amounts, we need someone to explain what is going on in details..

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