Rejig of Defence Budget 2014-15?

Recent media reports have referred to the possible decision of the government to divert INR 13,000 crore from the capital segment of the defence budget to the revenue heads. They have pointed to the adverse impact such a move would have on the modernization of the armed forces, especially with regard to the acquisition of new equipment. The reports note that around 80 per cent of the capital budget is spent on meeting the committed liabilities, thus leaving little money for new acquisitions. The need to maintain the sanctity of the budgetary process would prevent the Ministry of Defence (MOD) or the Ministry of Finance (MoF) from confirming this measure. But the press seldom gets its core facts wrong. Assuming, therefore, that these reports are true, it would be prudent to look at the issue in the wider context.

It is around December and January that the MoF firms up the revised estimates (RE) for a current financial year. The REs are primarily based on the latest figures of actual expenditure during the current financial year and the expenditure that various ministries and departments are likely to make during the remaining months of the year. If these two figures add up to a sum that is less than the amount allocated at the beginning of the financial year, it is mopped up by the MoF which is always hard pressed to match the overall expenditure with the revenue expected to be generated without breaching the deficit targets.

If INR 13,000 crore has been ‘diverted’, it would surely have been as a result of such an exercise by the MoF, but carried out in consultation with the MoD. In other words, this amount would have been reduced from the capital budget only on the basis of a realistic assessment that it would, in all probability, remain unutilized at the end of the current financial year.

While the scale of reduction this year might turn out to be unprecedented, reduction per se is a regular feature. Between the financial years 2002-03 and 2013-14, the capital budget was reduced at the RE stage every single year, barring 2010-11 when it was actually increased by a small margin. As recently as in 2012-13, it was reduced by a whopping INR 10,000 crore, followed by approximately INR 8,000 crore the next year.

The fact that in 2010-11 the allocation was increased at the RE stage and the MoD actually ended up spending more than even the revised allocation only indicates that reduction or increase at the RE stage is a need-based exercise. The expenditure has been exceeding the RE every year since then.

As regards the impact of such reductions on modernization of the armed forces, it is pertinent to note that the entire capital budget of defence is not spent on capital acquisitions meant for modernization of the armed forces. The capital budget has two notional segments – capital acquisition/modernization and the ‘other-than-capital acquisition’. In a broad sense, the entire capital budget of the Defence Research and Development Organization (DRDO) and the Ordnance Factories forms part of the latter. So does the allocation made for acquisition of land and capital works of the armed forces.

Out of INR 94,588 crore allocated under the capital segment in the current financial year’s defence budget, the amount earmarked for capital acquisition was around INR 75,315 crore, or a little less than 80 per cent of the total capital budget. Press reports give the impression that the entire reduction has been effected from the capital acquisition segment of the budget without actually categorically stating so. Though this possibility cannot be ruled out, it cannot be a foregone conclusion, however.

In the regular budget for 2014-15 presented by the NDA government in July 2014, the capital budget was increased by INR 5,000 crore over the allocation made earlier in the interim budget. A major share (INR 3,323 crore) went to the DRDO, followed by INR 1,000 crore for the defence rail network and INR 677 crore for capital expenditure by the Ordnance Factories. It will be surprising if this entire money gets spent by the end of the current fiscal.

The aforesaid allocations are a part of the ‘other-than-capital acquisition’ segment of the capital budget (around INR 19,270 crore), which also includes more than INR 1,230 crore for acquisition of land (including land and construction cost of the war memorial) and more than INR 7,200 for execution of capital works for the armed forces. It is not unusual for allocation under these heads not getting fully utilized.

Thus, the chances are that the ‘diverted’ amount would comprise the amount likely to remain unutilized under the capital acquisition as well as the ‘other-than-capital acquisition’ segments of the capital budget.

Even if it were to be assumed that the entire cut would be on the capital acquisition budget, does it ipso facto entail an adverse impact on the modernization drive of the armed forces? Not if one accepts that the extent of reduction is directly related to the sum total of the amount already spent when the RE is finalised and the requirement of funds for the new capital acquisition contracts likely to be signed before the end of the financial year. A fair assessment of such a requirement is always made as a part of the budgetary exercise.

One question still remains however: since a large proportion of the capital acquisition budget is spent on meeting the committed liabilities, does reduction in the allocation leaves little for new acquisitions?

Most of the defence equipment is not available, and cannot be bought, off the shelf. It is not as if one can go around and pick up the stuff if there is money in the pocket. Defence contracts are normally the culmination of a long drawn process with delivery schedules stretching over years. Payments are related to contractual milestones and delivery schedules. Therefore, one does not need the entire amount for which a contract is signed during the year in which it is signed.

There is very little chance of any new equipment being bought in the last quarter of the financial year unless the acquisition process has already reached the stage where the contract could be signed. In such cases, the requirement of funds on account of such contracts is indeed taken into account while firming up the revised estimates.

More than anything else, if the entire amount of INR 13,000 is being diverted to meet the revenue expenditure, it is an indication of the growing strain on the revenue budget. That should be a matter of concern as much as the slow pace of capital acquisition, which is not necessarily on account of reduction of allocation at the RE stage.

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