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India’s Defence Budget: As Border Tensions With China Simmer, Can Govt Level Up?

The fiscal reassurance is necessary because India's strategic & security environment is much different from 2014.

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India’s Defence Budget: As Border Tensions With China Simmer, Can Govt Level Up?
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(This is part 4 of our series and special coverage of the upcoming Union Budget, 2023. Read Part 1, Part 2, Part 3 )

As soon as the Union Defence Budget goes live, another cycle of discussions on its size and composition will begin. Analysts will focus on how the expenditures deviate from the previous year. The government on its part, will compare the current spending to what it was in 2014 to impress upon us that it has done enough.

Such discussions are of limited value. The budget is only a financial statement based on the government's priorities. The Defence Budget is then, a result of intra-governmental negotiations that consider India's threat perceptions, national security goals, defence capabilities, and the economic climate. As the government doesn't release any of these upstream ideas as official public documents, the Defence Budget becomes a focal point for understanding India's stance.

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Given this reality, the Defence Budget serves a limited but essential function. It needs to inspire confidence in the strategic community that India has enough fiscal power to manage the China challenge over the next few years.

How Must India Rise to the China Challenge?

The fiscal reassurance is necessary because India's strategic environment is much different than in 2014. Terrorism is no longer the threat that it was back then. Pakistan—the primary strategic challenge then has had a tough decade. International support for its military-jihadi complex has declined even as it has to contend with the Taliban on its western border and with economic mismanagement internally.

Meanwhile, Chinese actions along the border since 2017 have made it clear that India faces a wealthier and more capable primary strategic adversary over the next decade. Our Defence Budgets should have begun to reflect this fundamental change in the security environment. But a look at the numbers doesn't suggest so.

At the start of the decade (FY12), defence expenditure made up 2.8 per cent of GDP and 17.6 per cent of Union government expenditure. By FY22, this has declined to 2.1 per cent of GDP and 14 per cent of Union government expenditure.

In other words, defence has slipped in priority relative to non-defence functions. Moreover, the expenditure profile has skewed towards higher personnel costs, such as salaries and pensions, at the expense of an almost equivalent drop in capital outlay and stores (operational and maintenance expenditure).

The government addressed some of these issues last year. The Agnipath scheme could reduce pension expenditure, but those savings will accrue only after fifteen years. The government also increased capital outlay in the previous budget. It now makes up 29% of defence expenditure compared to 24.5% in FY20.
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Moreover, the navy's share in this capital expenditure, has increased to 35% up from the 27% range between FY16 and FY20. Budgetary allocations suggest that the government is trying to build up India's naval strength in response to China's challenge on the northern borders.

But these changes aren't enough. They are still incrementally positive changes. To build strength against China, the government needs to move forward on two counts.

Defence Financing Must Be a Priority for Govt

The defence finance crunch cannot be solved by the Ministry of Defence alone. The solution lies in a whole-of-government approach in which the government prioritises defence expenditure in line with future threat projections, even if it means reducing expenditure elsewhere. The good news is that there is enough slack in government expenditure which, if reduced, can permit defence modernisation without affecting key developmental priorities like health, education, food and water. There are three areas where expenditure can be curtailed. 

One, cut non-merit subsidies. Economists Sudipto Mundle and Satadru Sikdar find that in 2015–2016, unwarranted, non-merit subsidies of the Union and all state governments combined amounted to over 5.7 per cent of GDP. The Union government doles out nearly a fourth of this. Even halving this subsidy bill can free up a fiscal space of almost 0.8 per cent of GDP.

Two, rationalise centrally sponsored and central sector schemes. Currently totalling 116, many of the Union government schemes encroach on the domain of state governments. Rationalising them will create fiscal space for defence.

Three, sell non-strategic firms. There are currently 249 operating Central Public Sector Enterprises (CPSEs). The Union government should divest its stake from all CPSEs except a select few of core strategic importance. It is unconscionable for the government to cut defence spending while injecting taxpayers' money into failing companies.
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Non-Lapsable Fund for Capital Acquisition

Multiple parliamentary standing committees on defence have repeatedly highlighted the need for a non-lapsable defence capital fund account as a budgetary mechanism for handling the multi-year capital acquisition processes.

The Fifteenth Finance Commission also recommended the creation of such a fund. Since capital acquisition is a complex process spanning multiple years, a non-lapsable capital account would be helpful in the seamless carryover of surplus funds from one year to the next instead of the standard budgetary procedure of handing over unutilised funds back to the Consolidated Fund of India. Last year's budget didn't mention this reform, even though the union government had given an in-principle agreement way back in Feb 2021. 

Money can be drawn out of this non-lapsable fund as and when a capital acquisition deal fructifies. Crucially, such a fund can be seeded by the defence ministry using two revenue streams. One stream is monetising non-essential defence land.

The defence ministry is the biggest landholder of the union government, a lot of which is now prime real estate in India's major urban centres. Selling some of this land can generate the resources to build bigger and better defence facilities away from city centres while the surplus can be parked in the capital account fund. It is immoral for the government to hold on to this land while compromising defence modernisation.
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The second potential source for seeding the capital acquisition fund is to divest stakes in underperforming defence public sector enterprises. There are nine defence public sector undertakings and 39 ordnance factories under the defence ministry, operating at widely varying performance levels. Privatising some of these can help populate the capital acquisition fund.

The defence budget is another opportunity for the government to signal to its citizens and the world that it can take tough fiscal decisions in the interest of India's defence. Don't let it go to waste.

(Pranay Kotasthane is a Research Fellow at The Takshashila Institution. He tweets @pranaykotas. This is a personal blog, and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)

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