Mr Amit Cowshish is a former Financial Advisor (Acquisition), Ministry of Defence and former Distinguished Fellow, Manohar Parrikar Institute for Defence Studies and Analyses, New Delhi. Click here for Detailed Profile
As reported in a section of the press on November 11, 2012, the Defence Minister has said that there would be no cut in the budget for buying ammunition, platforms and equipment necessary for operational preparedness of the armed forces, although he added a word of caution by saying that everything depends on the government’s financial situation. The statement is reassuring but it is at odds with the alarm bells rung by Finance Minister P. Chidambaram earlier this month at the meeting of the council of ministers about the state of the economy. Chidambaram is reported to have urged his colleagues to curb expenditure and raise resources during the remainder of the current fiscal year so as to prevent India from falling into the junk grade on account of credit worthiness. This was not a sudden development. Five months earlier, the Ministry of Finance had imposed a 10 per cent cut on all non-plan expenditure, excluding, inter alia, salaries and defence capital. How does all this impact the defence budget?
The two-pronged strategy to deal with the fiscal crisis is intended to generate additional revenue primarily through disinvestment and spectrum auction on one hand and curb expenditure on the other. The Ministry of Defence can play only a rather limited role in generating additional revenue. Apart from INR 3,000 crore expected to be raised through disinvestment of 10 per cent of the government’s stake in the Hindustan Aeronautics Limited, the defence budget for the current year envisages receipts and recoveries by the Services and other departments to the tune of INR 5,007.61 crore. Keeping in view the nature of these receipts and recoveries and also going by the previous trend, there is unlikely to be any substantial increase on this account. In any case, the Ministry of Defence is not a revenue earning department and, therefore, it cannot be expected to play a significant role in respect of the revenue-generation aspect of the strategy presented by the Finance Minister to the cabinet. However, it is the second part of the strategy relating to curbing of expenditure that has a direct bearing on the defence budget and, by implication, on defence preparedness.
The enormity of the defence budget, which stands at INR 1,93,407.29 crore for the current fiscal year, makes it vulnerable to massive cuts as a means of fiscal adjustment. It is, therefore, natural that defence expenditure would come under a close scrutiny by the Ministry of Finance, which is desperate to contain the fiscal deficit during the current year. Reduction in budgetary allocations is not unprecedented and it is unlikely to be any different this year. As reported in the press last week, spending on even the social sector is likely to come down, with the Finance Ministry threatening to cut down the allocation by as much as 40 per cent for the sake of fiscal consolidation. Under the circumstances, the Ministry of Defence would be lucky to get away with a 10 per cent cut, even if it can ill afford it.
Where would this cut pinch the most? The economy instructions of May 2012 exempt the salary budget and the defence capital budget from the mandatory cut. This implies that the cut is to be imposed on the other-than-salary segment of the revenue budget, which stands at INR 38,776.74 crore for the current year. A 10 per cent cut would mean reduction in the allocation by INR 3,877.68 crore; but it is difficult to see how this can be achieved, especially in view of the fact that the budgetary allocation this year, as indeed in the past, has been less than the requirement projected by the Ministry of Defence. The Services, in particular, have been raising the issue of inadequate allocations for a long time. According to the 15th report of the Standing Committee on Defence (15th Lok Sabha), the Indian Army received approximately INR 6,500 crore less than what it had asked for under the revenue segment (including salaries) for the current year. For the Indian Air Force and the Indian Navy, the gap between projection and allocation under the revenue segment for the current year was approximately INR 3,300 crore and INR 2,100 crore, respectively. Since the allocation ab initio is inadequate, it is thinly spread over the budget heads. As per the standing instructions, the requirement of funds for pay & allowances and other committed liabilities have to be fully met while allocating funds to various budget heads. Consequently, the allocation-spread gets thinner and thinner when it comes to the budget heads under the other-than-salary segment of the revenue budget.
In so far as the defence services are concerned, the other-than-salary segment of the revenue budget mainly comprises four budget heads. These are transportation, stores, revenue works and other expenditure. This segment also includes the expenditure on the Ex-servicemen Health Scheme (ECHS). In the case of the Indian Navy, there is another budget head related to repairs and refit of naval vessels. Under the budget head of transportation, which caters for the expenditure on movement of stores and personnel and the budget head of revenue works, which caters for the expenditure on maintenance of buildings and other installations, the actual allocations for the current year are less than the revised estimates for the previous year. (The revised estimates are a truer indicator of the actual utilisation.) It is unimaginable how the allocation under these heads could be reduced further. Under the budget head related to other expenditure, the current year’s allocation is just INR 606.66 crore more than the revised estimates for the previous year. The expenditure incurred from this head includes conservancy and hot weather establishment charges; unit allowances; amenities to troops; various training grants; payment to the Department of Post; telephone charges; expenditure on procurement of maps and satellite images; expenses related to sports and adventure activities; printing and purchase of stationery; and, all expenditure related to the welfare-oriented Operation Sadbhavna in Jammu & Kashmir. These are just a few objects on which expenditure is incurred from this budget head by innumerable units, formations and other establishments spread all over the country, with each one of them managing a fraction of the allocation under this budget head. This bewildering variety of expenditure incurred by a very large number of spending authorities offers little scope for effecting any cut – even if it is a seemingly meagre cut of 10 per cent.
The allocation for ECHS too has no scope for any cut. At INR 1,000 crore, the current year’s allocation is INR 55.31 crore less than the actual expenditure incurred in 2010-11 and INR 109.95 crore less than the revised estimates for the previous year. Approximately 21 per cent of the ECHS budget is spent on pay & allowances, while 73 per cent is spent on medical stores and treatment of the beneficiaries. Medical treatment is not getting any cheaper, nor is there any indication of any declining trend in the number of patients. Under the circumstances, the possibility of any further reduction in the current year’s allocation for ECHS, which is already less than last year’s revised estimates, gets automatically ruled out.
This leaves us with only one broad budgetary head of stores and another Indian Navy-specific budget head of repairs and refit. The Stores budget head caters for the expenditure on purchase of ammunition, minor equipment, ration, clothing and all other types of stores for maintenance of equipment and weapon systems. This head also caters for expenditure on aviation fuel, petrol, oil and lubricants. With the expenditure on refits being increasingly met from the capital budget, the repairs and refit budget head of the Indian Navy now caters for the expenditure only on repairs of naval vessels. At INR 21,823.05 crore, including INR 700 crore for repairs and refit, this is the second largest category of expenditure after pay & allowances under the revenue segment of the current year’s defence budget. This is just INR 1,876.16 crore more than last year’s revised estimates. With the increase in prices of practically all types of stores procured from this budget head, as also additional expenditure on account of new raisings and improved scales and quality of rations and clothing, the scope for containing expenditure under this category is extremely restricted. Since the expenditure on rations, clothing and fuel cannot be reduced for obvious reasons, the axe generally falls on purchase of ammunition and other equipment, as also on the expenditure on maintenance, both of which have serious implications for operational preparedness.
According to the 15th report of the Standing Committee on Defence (15th Lok Sabha), the Ministry of Defence had conceded that after providing for salary and other obligatory expenses the balance allocation is distributed to meet the requirement under stores (including ordnance), transportation (of personnel and stores), revenue works and maintenance, etc., and that these areas are likely to be impacted by the reduction in allocation. The same report also refers to the statement of the representative of the Indian Air Force that a shortfall in the revenue budget would impact its capabilities since legacy systems require more maintenance as they are old, apart from resulting in shortfall in training because of which eventually the operational preparedness would be compromised. These statements were made in the context of the budgetary allocations being less than the projection. Imagine the impact if the inadequate allocation made at the beginning of the year were to be subjected to a further cut of 10 per cent.
While the revenue budget is quite inelastic, the capital budget presents a different set of challenges. The expenditure on equipment, ranging from tanks to aircraft and submarines, and other weapons systems, as also on purchase of land and construction of buildings and other infrastructure is incurred from the capital budget, which has been exempted by the Ministry of Finance from the mandatory 10 per cent cut. However, the Ministry of Finance has, on many occasions in the past, reduced the allocations at the revised estimate stage, ostensibly on the grounds that the pace of expenditure in the first three quarters of the year had been slow. According to the standing instructions of the Ministry of Finance, ministries and departments that do not spend 67 per cent of the allocation by the end of the third quarter face the prospect of their allocation for the fourth quarter being fixed at one-third of the expenditure incurred till the end of the third quarter of that year.
The Ministry of Defence has always been on a rather slippery wicket in this regard. It is no different this year. According to the figures compiled by the Controller General of Accounts, the total expenditure against the budgetary allocation of INR 1.93 lakh crore stood at 44 per cent at the end of October 2012. This respectable level has been achieved because of the revenue expenditure, which stood at 50 per cent, compensating for the slow progress of capital expenditure, which had reached only 35 per cent of the capital budget at the end of the second quarter of the year. With this pace of utilisation, it is difficult to say whether the capital expenditure would reach 67 per cent by the end of December 2012 to be able to avoid a cut based on the progress of expenditure.
The Ministry of Finance has been reducing the capital budget at the revised estimate stage based on the pace of expenditure, though not strictly as per the aforesaid formula, leaving just about enough funds to meet the expenditure on account of the committed liabilities, as also some inescapable contractual payments related to new schemes, during the last quarter. The Ministry of Defence has been at pains to explain to the Ministry of Finance that the expenditure on defence cannot conform to the discipline of even cash flow. Peaks and troughs are inevitable because of a number of reasons, which cannot be explained here. However, since this argument has not cut much ice with the Ministry of Finance in the past, it is more unlikely to impress the mandarins in North Block in this year of a fiscal crisis. Therefore, a reduction in the capital budget cannot be ruled out this year as well. Although it may not have an immediate impact on the on-going procurement proposals, this would certainly increase the pressure on the capital budget in future because of some of the new procurement proposals getting pushed to the next year. All these calculations may, however, go awry if the Medium Multi-Role Combat Aircraft (MMRCA) contract gets signed during the current financial year, making it obligatory to cough up 15 per cent of the contract value by way of advance payment to the vendor.
So what does all this add up to? Simply stated, on the capital side, there may not be much of an adverse impact of reduction in allocation if the MMRCA contract gets pushed to the next year but the Ministry of Defence would, in all probability, be under pressure to achieve a respectable level of expenditure by the end of the third quarter to be able to avoid reduction in allocation at the revised estimate stage on account of slow pace of expenditure. On the revenue side, procurement of ammunition and other equipment as well as maintenance of legacy systems would be adversely affected, irrespective of whether or not the 10 per cent cut is imposed on an already inadequate allocation.
This is not to suggest that there is no scope for better management of finances but this cannot certainly be achieved through arbitrary cuts imposed on inadequate allocations or by asking the Services and other departments to prioritise their purchases. Procurement of goods and services is a long drawn out process and it cannot be commenced, paused or re-commenced at short notice. Like in the previous years, the Ministry of Defence would pass on the responsibility to the Services and other departments who may tide over the crisis partly by deferring some payments and partly by overspending but it is necessary for the Ministry of Defence to take a long-term view for better management of finances rather than insulating itself from the travails of the Services and other departments. The government had set up a Defence Review Expenditure Committee under a former Secretary (Defence Finance), which submitted its report more than three years ago. One of the recommendations made by this committee was regarding the setting up of a Defence Planning Board. Among other things, an entity like this could also take a long term comprehensive view concerning the management of finances.
Cut in Defence Budget 2012-13: Prospects and Consequences
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As reported in a section of the press on November 11, 2012, the Defence Minister has said that there would be no cut in the budget for buying ammunition, platforms and equipment necessary for operational preparedness of the armed forces, although he added a word of caution by saying that everything depends on the government’s financial situation. The statement is reassuring but it is at odds with the alarm bells rung by Finance Minister P. Chidambaram earlier this month at the meeting of the council of ministers about the state of the economy. Chidambaram is reported to have urged his colleagues to curb expenditure and raise resources during the remainder of the current fiscal year so as to prevent India from falling into the junk grade on account of credit worthiness. This was not a sudden development. Five months earlier, the Ministry of Finance had imposed a 10 per cent cut on all non-plan expenditure, excluding, inter alia, salaries and defence capital. How does all this impact the defence budget?
The two-pronged strategy to deal with the fiscal crisis is intended to generate additional revenue primarily through disinvestment and spectrum auction on one hand and curb expenditure on the other. The Ministry of Defence can play only a rather limited role in generating additional revenue. Apart from INR 3,000 crore expected to be raised through disinvestment of 10 per cent of the government’s stake in the Hindustan Aeronautics Limited, the defence budget for the current year envisages receipts and recoveries by the Services and other departments to the tune of INR 5,007.61 crore. Keeping in view the nature of these receipts and recoveries and also going by the previous trend, there is unlikely to be any substantial increase on this account. In any case, the Ministry of Defence is not a revenue earning department and, therefore, it cannot be expected to play a significant role in respect of the revenue-generation aspect of the strategy presented by the Finance Minister to the cabinet. However, it is the second part of the strategy relating to curbing of expenditure that has a direct bearing on the defence budget and, by implication, on defence preparedness.
The enormity of the defence budget, which stands at INR 1,93,407.29 crore for the current fiscal year, makes it vulnerable to massive cuts as a means of fiscal adjustment. It is, therefore, natural that defence expenditure would come under a close scrutiny by the Ministry of Finance, which is desperate to contain the fiscal deficit during the current year. Reduction in budgetary allocations is not unprecedented and it is unlikely to be any different this year. As reported in the press last week, spending on even the social sector is likely to come down, with the Finance Ministry threatening to cut down the allocation by as much as 40 per cent for the sake of fiscal consolidation. Under the circumstances, the Ministry of Defence would be lucky to get away with a 10 per cent cut, even if it can ill afford it.
Where would this cut pinch the most? The economy instructions of May 2012 exempt the salary budget and the defence capital budget from the mandatory cut. This implies that the cut is to be imposed on the other-than-salary segment of the revenue budget, which stands at INR 38,776.74 crore for the current year. A 10 per cent cut would mean reduction in the allocation by INR 3,877.68 crore; but it is difficult to see how this can be achieved, especially in view of the fact that the budgetary allocation this year, as indeed in the past, has been less than the requirement projected by the Ministry of Defence. The Services, in particular, have been raising the issue of inadequate allocations for a long time. According to the 15th report of the Standing Committee on Defence (15th Lok Sabha), the Indian Army received approximately INR 6,500 crore less than what it had asked for under the revenue segment (including salaries) for the current year. For the Indian Air Force and the Indian Navy, the gap between projection and allocation under the revenue segment for the current year was approximately INR 3,300 crore and INR 2,100 crore, respectively. Since the allocation ab initio is inadequate, it is thinly spread over the budget heads. As per the standing instructions, the requirement of funds for pay & allowances and other committed liabilities have to be fully met while allocating funds to various budget heads. Consequently, the allocation-spread gets thinner and thinner when it comes to the budget heads under the other-than-salary segment of the revenue budget.
In so far as the defence services are concerned, the other-than-salary segment of the revenue budget mainly comprises four budget heads. These are transportation, stores, revenue works and other expenditure. This segment also includes the expenditure on the Ex-servicemen Health Scheme (ECHS). In the case of the Indian Navy, there is another budget head related to repairs and refit of naval vessels. Under the budget head of transportation, which caters for the expenditure on movement of stores and personnel and the budget head of revenue works, which caters for the expenditure on maintenance of buildings and other installations, the actual allocations for the current year are less than the revised estimates for the previous year. (The revised estimates are a truer indicator of the actual utilisation.) It is unimaginable how the allocation under these heads could be reduced further. Under the budget head related to other expenditure, the current year’s allocation is just INR 606.66 crore more than the revised estimates for the previous year. The expenditure incurred from this head includes conservancy and hot weather establishment charges; unit allowances; amenities to troops; various training grants; payment to the Department of Post; telephone charges; expenditure on procurement of maps and satellite images; expenses related to sports and adventure activities; printing and purchase of stationery; and, all expenditure related to the welfare-oriented Operation Sadbhavna in Jammu & Kashmir. These are just a few objects on which expenditure is incurred from this budget head by innumerable units, formations and other establishments spread all over the country, with each one of them managing a fraction of the allocation under this budget head. This bewildering variety of expenditure incurred by a very large number of spending authorities offers little scope for effecting any cut – even if it is a seemingly meagre cut of 10 per cent.
The allocation for ECHS too has no scope for any cut. At INR 1,000 crore, the current year’s allocation is INR 55.31 crore less than the actual expenditure incurred in 2010-11 and INR 109.95 crore less than the revised estimates for the previous year. Approximately 21 per cent of the ECHS budget is spent on pay & allowances, while 73 per cent is spent on medical stores and treatment of the beneficiaries. Medical treatment is not getting any cheaper, nor is there any indication of any declining trend in the number of patients. Under the circumstances, the possibility of any further reduction in the current year’s allocation for ECHS, which is already less than last year’s revised estimates, gets automatically ruled out.
This leaves us with only one broad budgetary head of stores and another Indian Navy-specific budget head of repairs and refit. The Stores budget head caters for the expenditure on purchase of ammunition, minor equipment, ration, clothing and all other types of stores for maintenance of equipment and weapon systems. This head also caters for expenditure on aviation fuel, petrol, oil and lubricants. With the expenditure on refits being increasingly met from the capital budget, the repairs and refit budget head of the Indian Navy now caters for the expenditure only on repairs of naval vessels. At INR 21,823.05 crore, including INR 700 crore for repairs and refit, this is the second largest category of expenditure after pay & allowances under the revenue segment of the current year’s defence budget. This is just INR 1,876.16 crore more than last year’s revised estimates. With the increase in prices of practically all types of stores procured from this budget head, as also additional expenditure on account of new raisings and improved scales and quality of rations and clothing, the scope for containing expenditure under this category is extremely restricted. Since the expenditure on rations, clothing and fuel cannot be reduced for obvious reasons, the axe generally falls on purchase of ammunition and other equipment, as also on the expenditure on maintenance, both of which have serious implications for operational preparedness.
According to the 15th report of the Standing Committee on Defence (15th Lok Sabha), the Ministry of Defence had conceded that after providing for salary and other obligatory expenses the balance allocation is distributed to meet the requirement under stores (including ordnance), transportation (of personnel and stores), revenue works and maintenance, etc., and that these areas are likely to be impacted by the reduction in allocation. The same report also refers to the statement of the representative of the Indian Air Force that a shortfall in the revenue budget would impact its capabilities since legacy systems require more maintenance as they are old, apart from resulting in shortfall in training because of which eventually the operational preparedness would be compromised. These statements were made in the context of the budgetary allocations being less than the projection. Imagine the impact if the inadequate allocation made at the beginning of the year were to be subjected to a further cut of 10 per cent.
While the revenue budget is quite inelastic, the capital budget presents a different set of challenges. The expenditure on equipment, ranging from tanks to aircraft and submarines, and other weapons systems, as also on purchase of land and construction of buildings and other infrastructure is incurred from the capital budget, which has been exempted by the Ministry of Finance from the mandatory 10 per cent cut. However, the Ministry of Finance has, on many occasions in the past, reduced the allocations at the revised estimate stage, ostensibly on the grounds that the pace of expenditure in the first three quarters of the year had been slow. According to the standing instructions of the Ministry of Finance, ministries and departments that do not spend 67 per cent of the allocation by the end of the third quarter face the prospect of their allocation for the fourth quarter being fixed at one-third of the expenditure incurred till the end of the third quarter of that year.
The Ministry of Defence has always been on a rather slippery wicket in this regard. It is no different this year. According to the figures compiled by the Controller General of Accounts, the total expenditure against the budgetary allocation of INR 1.93 lakh crore stood at 44 per cent at the end of October 2012. This respectable level has been achieved because of the revenue expenditure, which stood at 50 per cent, compensating for the slow progress of capital expenditure, which had reached only 35 per cent of the capital budget at the end of the second quarter of the year. With this pace of utilisation, it is difficult to say whether the capital expenditure would reach 67 per cent by the end of December 2012 to be able to avoid a cut based on the progress of expenditure.
The Ministry of Finance has been reducing the capital budget at the revised estimate stage based on the pace of expenditure, though not strictly as per the aforesaid formula, leaving just about enough funds to meet the expenditure on account of the committed liabilities, as also some inescapable contractual payments related to new schemes, during the last quarter. The Ministry of Defence has been at pains to explain to the Ministry of Finance that the expenditure on defence cannot conform to the discipline of even cash flow. Peaks and troughs are inevitable because of a number of reasons, which cannot be explained here. However, since this argument has not cut much ice with the Ministry of Finance in the past, it is more unlikely to impress the mandarins in North Block in this year of a fiscal crisis. Therefore, a reduction in the capital budget cannot be ruled out this year as well. Although it may not have an immediate impact on the on-going procurement proposals, this would certainly increase the pressure on the capital budget in future because of some of the new procurement proposals getting pushed to the next year. All these calculations may, however, go awry if the Medium Multi-Role Combat Aircraft (MMRCA) contract gets signed during the current financial year, making it obligatory to cough up 15 per cent of the contract value by way of advance payment to the vendor.
So what does all this add up to? Simply stated, on the capital side, there may not be much of an adverse impact of reduction in allocation if the MMRCA contract gets pushed to the next year but the Ministry of Defence would, in all probability, be under pressure to achieve a respectable level of expenditure by the end of the third quarter to be able to avoid reduction in allocation at the revised estimate stage on account of slow pace of expenditure. On the revenue side, procurement of ammunition and other equipment as well as maintenance of legacy systems would be adversely affected, irrespective of whether or not the 10 per cent cut is imposed on an already inadequate allocation.
This is not to suggest that there is no scope for better management of finances but this cannot certainly be achieved through arbitrary cuts imposed on inadequate allocations or by asking the Services and other departments to prioritise their purchases. Procurement of goods and services is a long drawn out process and it cannot be commenced, paused or re-commenced at short notice. Like in the previous years, the Ministry of Defence would pass on the responsibility to the Services and other departments who may tide over the crisis partly by deferring some payments and partly by overspending but it is necessary for the Ministry of Defence to take a long-term view for better management of finances rather than insulating itself from the travails of the Services and other departments. The government had set up a Defence Review Expenditure Committee under a former Secretary (Defence Finance), which submitted its report more than three years ago. One of the recommendations made by this committee was regarding the setting up of a Defence Planning Board. Among other things, an entity like this could also take a long term comprehensive view concerning the management of finances.
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