Dr Subhash Chandra Pandey, IAAS, Former Special Secretary, Ministry of Commere and Industry, Govt of India
The 15th Finance Commission has recommended the constitution of a dedicated Modernisation Fund for Defence and Internal Security to bridge the gaps between the projected budgetary requirement and budget allocation for capital expenditure on defence and internal security.
Here is an attempt to assess the need and implications of such a recommendation.
Defence and internal security are the paramount needs of any country and catering to it adequately is a critical sovereign function involving substantial fiscal resources. These are considered to be among the primary charges on the nation’s tax resources. In view of the complex and evolving spectrum of security challenges, modernisation of the defence and internal security apparatus is a continuous process, based on threat perception, operational challenges and technological advances.
Defence expenditure has, over time, been characterised by a higher share of revenue expenditure, huge pension bills and lower capital expenditure with high dependence on import of defence equipment. It has become imperative to review the structure of defence expenditure in order to ensure greater predictability and stability in the flow of adequate funds for its capital needs and to find ways to reduce growth in revenue expenditure, especially rising pension outlays.
The Ministry of Defence (MoD) has the highest allocation among all Union ministries. Over the last ten years, the defence budget has shown a trend growth rate of 9.6 per cent. Within this, revenue expenditure has grown at 11 per cent and capital expenditure at only 6.1 per cent.
Although as a proportion of gross domestic product (GDP), total defence expenditure has decreased between 2011-12 and 2018-19 (from 2.5 per cent to 2.1 per cent), the proportion of total defence expenditure in total Union Government expenditure has increased from 16.4 per cent to 17.4 per cent during the same period. This is also in the background of a decline in total Union Government expenditure from 14.9 per cent of GDP in 2011-12 to 12.2 per cent of GDP in 2018-19. The increase is largely accounted for by defence revenue expenditure which rose from 12.6 per cent of the Union Government’s revenue expenditure in 2011-12 to 15.1 per cent in 2018-19 .
A key feature of defence capital expenditure is the dependence on imports. According to the Stockholm International Peace Research Institute, India was the fourth-largest importer of defence goods and services in 2018. Imports of military hardware result in the country losing out on the multiplier effects on the economy as well as on spin-offs in terms of technical and scientific inventions and innovations, which domestic production will result in. Furthermore, the dependence on foreign suppliers for military hardware not only entails huge expenditure on imports, but also makes national security vulnerable to vagaries of supply during emergencies. There has been a recent thrust for indigenous production of defence equipment but it needs to be matched with predictability and stability in the flow of adequate resources for capital investment as part of overall strategy of defence modernisation.
The MoD had suggested several options for funding defence modernisation to the Finance Commission such as (i) carving out a certain portion of the shareable pool for defence and internal security before the vertical devolution (ii) monetisation of defence land, (iii) a defence or national security cess (iv) defence bonds (v) making the profits that accrue to defence public sector enterprises (DPSEs) and ordnance factories from defence exports available exclusively for defence purposes; (vi) proceeds from the disinvestment of DPSEs (vii) augmentation of defence receipts by reimbursement of expenditure incurred on Humanitarian Aid and Disaster Relief, aid to State and civil authorities and United Nations missions;(viii) one-time lump-sum grants to the defence services by re-appropriation of underutilised heads across various demands of grants by the Ministry of Finance; and (ix) exemption from levy of statutory duties like customs duty, goods and services tax (GST) and integrated GST on the purchase and acquisitions by the services.
Like the MoD, the MHA also emphasised the need for increase in outlays with greater degree of predictability in allocations. At the same time, it pointed out that the increased devolution to States did not result in any incremental increase by State Governments in their allocations to the police. Thus, the MHA felt that there is a definite need for a separate mechanism for funding of internal security, as the Ministry did not have many alternative sources for funding, such as sale of surplus land.
The Ministry of Finance (MoF) stated that defence expenditure is entirely the responsibility of the Union Government as it is a Union List subject. However, States also enjoy the benefits of peace within the country and security at the national borders. Economic growth and development in States will not be possible without these two fundamental sovereign functions being satisfactorily carried out. Union Government’s requirements for the defence sector are an inviolable priority and it is imperative that defence expenditure keeps pace with the security challenges facing the country.
Finance Ministry has acknowledged that it may not be possible for the Commission to set aside expenditure on defence from the pool of shareable taxes, but it urged that the imperative of defence expenditure be recognised while considering the requirements of the Union. With heavy capital expenditure being incurred by the MoD in the last ten years, the burden of maintenance of defence acquisitions is going to increase the demand for revenue expenditure in the coming years.
Finance Ministry further stated that defence planning and capability building is a lengthy process which requires long term commitment of funds. Consistent increase in the capital outlay on defence services is required for aircraft and aero-engines, heavy and medium vehicles, other equipment, research and development and other special projects of the defence services.
The non-lapsable fund recommended by the Finance Commission will be under the Public Accounts and will have four sources of incremental funding: (i) transfers from the Consolidated Fund of India; (ii) disinvestment proceeds of defence public sector enterprises; (iii) proceeds from monetisation of surplus defence land; and (iv) proceeds of receipts from defence land likely to be transferred to State Governments and for public projects in future. The Fund shall have the standard notified rules for its administration, public reporting and audit by the Comptroller and Auditor General. The Commission has also recommended that MoD should take immediate measures to innovatively bring down the salaries and pension liabilities and reduce its dependence on defence imports, with a specific roadmap.
To raise additional resources, the MoD suggested three major sources of land which can be considered for monetisation: (a) land available after the closure of military farms; (b) abandoned air fields and camping grounds, and (c) encroached land for which efforts should be made to recover the cost of the land.
MoD had proposed Rs.55,000 crore as the annual size of the non-lapsable fund. The basis for estimating this amount is the average gap between projection and allocation of funds for the capital segment during the last five years. The Finance Commission has, however, recommended an indicative amount equal to 1 per cent of gross revenue receipts of Centre (estimated to be about Rs.1.53 lakh crore during the period of 2021-22 to 2025-26) being set aside for the special funding mechanism of non-lapsable fund which is for both MoD and MHA.
Since the procurement process itself is so long winding and the order implementation is fraught with so many uncertainties that actual expenditure estimates mostly go haywire. Orders are not placed as planned on big ticket items where advance itself is huge amount and in some cases, stage payments don’t fructify because of delays in execution of orders.
To what extent there would be actual augmentation of resources for MoD and MHA over next 5 years (from indicative incremental resource availability of Rs.1.53 lakh crore) will depend both on actual pace of defence land monetization and disinvestment of Defence PSUs etc. as well as in actual increase in normal budget allocation. In the past, opening of dedicated channels of financing of particular sectors (like education and roads) have led to growth in normal budget allocations getting slower.
A non-lapsable and assured source of finance can potentially minimize the spending spree in closing months, particularly the ‘March Rush’ including parking of funds in PSUs triggered by apprehension of surrender of funds. In part it leads to injudicious, hurried expenditure without due scrutiny.
The budget allocation for Ministry of Defence is made by the Ministry of Finance on a net budget basis which means the gross expenditure requirements less receipts, refunds and recoveries of expenditure earlier made. MoD has an in-built assurance of additional expenditure authorisation to the extent it is able to generate more receipts. However, this system applied to only revenue receipts and not to non-debt capital receipts like sale of land or disinvestment. It is difficult to estimate the figures of receipts. The non-lapsable fund fills this gap and allows MoD to seek additional expenditure authorization to match resource generation for government by way of land sale and disinvestment.
Viewed in an overall perspective, the move to create non-lapsable fund will certainly help in improving the expenditure management by Ministry of Defence.