IDSA COMMENT

Economic moorings of the defence budget

February 27, 2013

There has been a lot of speculation in the media about the cut in defence budget for the current financial year and the allocation for the next year (2013-14). It is literally just a matter of hours before the mystery gets solved. On February 28, the country would get to know what the Finance Minister has in store for defence. There are no prizes for guessing that there would be a downward revision of allocation for the current year, most of which would be in the capital budget. The total capital expenditure at the end of January 2013 was INR 55,218.34 crore, which works out to 69.39 per cent of the total capital allocation of INR 79,578.63 crore, leaving a balance of INR 24,360.29 crore to be spent in the months of February and March. In so far as the capital acquisition segment of the capital budget is concerned, the expenditure at the end of January 2013 was INR 46,722.19 crore, which works out to 70.75 per cent of the total capital acquisition budget of INR 66,032.24 crore, leaving a balance of INR 19,310.05 crore to be spent before the close of the year. The question whether the balance amount would have got utilized or not is moot at this stage. It will not matter as long as the ministry is able to meet its committed liabilities and make the advance payment due before the end of the year against any new contracts that have been signed.

If the writing on the wall is quite clear in so far as the current year’s revised estimates are concerned, it is not all that hazy in respect of next year’s budget also. But it would be hazardous to make a guess, except in terms of what is unlikely to happen. The most obvious thing unlikely to happen is a whopping increase in the defence budget. The resources that can be raised when the economy is growing at the rate of 5 to 6 per cent cannot be the same as the resources the government was able to raise when the economy was growing at 9 to 10 per cent per annum. The defence budget cannot be insulated from the vicissitudes of the economy. Resource allocation is a zero-sum game and allocation of scarce resources is an unenviable task. This is the simplest explanation for the most unlikely exponential increase in the defence budget.

The anguished outbursts that follow the announcement of the budget every year are understandable to some extent. The anguish over the state of modernization of the armed forces, the slow march towards achieving the capability for simultaneous action on two-fronts and rather feeble power projection on a global scale are understandable. The part that is not understandable is the expectation that the outlays for achieving these objectives would increase exponentially, irrespective of the state of the economy. This is what was tried out in Pakistan under the rubric of the ‘security state’ with rather disastrous results. That is, however, not to suggest that expectations of higher defence outlays in India are premised on the concept of a ‘security state’ but to point out that there is a danger inherent in insulating the defence outlays from the state of the economy.

There is also a tendency to look at the defence outlay in terms of its percentage to the gross domestic product (GDP) and decry the fact that it has come down below two per cent in recent years. In simple terms, GDP is the sum total of the monetary value of all the finished goods and services produced within the country in a given time period. Besides government outlays, this includes all private and public consumption, investments and exports, minus the imports. This is not the same as the resources available to the government for allocation. It is, therefore, an extraneous factor in so far as allocation of resources is concerned.

Japan has been spending just about one per cent of its GDP on defence for a long time, which is half of what India has been spending. On the other hand, Pakistan has been spending more than double of what India has been spending and more than four times what Japan has been spending, in terms of percentage of the GDP of the respective countries. It does not automatically imply that Pakistan is better placed as regards its security than India or Japan.

There are persistent demands for raising the allocation for defence to three percent of the GDP. The idea does not seem to be based on any empirical study that establishes the validity of this premise. On the other hand, the allocation and utilization data for the past years indicates the inability of the defence establishment to utilize the funds beyond a certain point, especially under the capital acquisition segment of the capital budget from which the modernization plans are funded. Between 2006-07 and 2011-12, the actual expenditure was INR 25,000 crore less than the initial allocation at the Budget Estimate stage. If the preceding four years are also added, the underutilization figure jumps to more than INR 35,500 crore for the 10-year period from 2002-03 to 2011-12. The allocation in terms of percentage of GDP during this period ranged between 1.84 (2007-08) to 2.34 (2004-05). Imagine the pressure on the Ministry of Defence to utilize the extra allocation, had the allocation been pegged at 3 per cent of the GDP. It can be argued that the ministry would have been able to utilize the extra funds had these been allotted under the revenue segment. This argument would perhaps be valid but then modernization of the armed forces is not funded from the revenue budget.

While on this issue, it must also be noted that what is generally known as defence budget does not include the outlay for the Ministry of Defence and defence pensions. The budget outlay for the Indian Coast Guard is a part of the former. The defence budget also does not include the outlay for the Border Roads Organization, which, in fact, is embedded in the demand for grant for the Ministry of Road Transport and Highways. The percentage of allocation for defence would be much higher if these outlays are also taken into account.

So what would be the ideal size of the defence budget? It is difficult to answer this question but it would be reasonable to say that it would suffice if the allocations are made as per the budgetary projections, which is generally never the case. This is a valid proposition but two things need to be kept in mind. One, there is indeed a tendency to inflate the requirement because the Ministry of Finance always allocates less than what is asked for. Two, there is no scientific and uniform method that is adopted by the Services and departments to assess their requirements realistically, except in some areas of expenditure. The biggest problem relates to costing. This is one of the weakest areas in the financial management of the defence budget.

There is another parameter on which the defence budget is judged every year: the ratio of capital expenditure to revenue expenditure. For some reason, 40:60 is considered to be an ideal ratio. The sanctity attached to this ratio is disproportionate to its virtue. There is no point in buying new equipment and weapon systems if these are not properly maintained and kept in a state of operational readiness. All maintenance-related expenditure is incurred from the revenue budget. In fact, the requirement under the revenue segment would go on increasing as new equipment and weapons systems are added to the inventory and new raisings are sanctioned by the government. One of the parameters on which the adequacy of the allocation should be judged is the level of serviceability of the equipment held by the armed forces. A micro-analysis would provide a better understanding of the defence budget than a macro-analysis based on the size of the budget, what it works out to in terms of percentage of the GDP and the revenue to capital ratio.

The defence budget is judged on yet another important parameter, which is in terms of its percentage to the total central government expenditure. In the last ten years (2002-03 to 2011-12), it has been in the range of 12.74 per cent in 2003-04 to 15.91 per cent in 2005-06. On an average, it has been around 13 per cent. It was around 15 per cent or more from 2004-05 to 2006-07, which is when the economy was growing at around 9 per cent per annum. Thus, here too, the linkage with the capacity of the government to spend and the state of the economy is evident. There are other factors too that influence the allocation, such as when the Sixth Central Pay Commission arrears were to be paid. Therefore, marginal increase or decrease in defence expenditure in relation to the total central government expenditure should not be disconcerting.

Some analysts argue that the problems related to inadequate funding of defence arise from the fact that it is non-plan expenditure. The Planning Commission is primarily concerned with development-oriented activities and programmes. It is, therefore, difficult to see how defence related programmes could be brought within the purview of the Planning Commission. But the idea needs to be developed further into a workable model without this exercise being driven by the hope that it would bring in more money for defence. The slashing of the plan outlay for the current year by INR 93,000 crore, as reported in the press, is a clear indication that the plan funds too are subject to cuts as much as the non-plan funds.

The underlying message here is that the allocation for defence is inextricably linked with the performance of the economy. The Ministry of Defence can play a significant part in boosting economic growth by curbing revenue expenditure and promoting manufacturing activity in the defence sector. While there are limitations on curbing revenue expenditure, there is vast scope for promoting manufacturing in the defence sector. There is a need for the Ministry of Defence to come out with a roadmap rather than waiting for Godot - to use the title of the celebrated tragicomedy of Samuel Beckett.

Amit Cowshish is Former Financial Advisor (Acquisition) & Additional secretary and Member, Defence procurement Board, Ministry of Defence.

Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India.