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IDSA COMMENT

Would a Non-Lapsable Defence Modernisation Fund Work?

February 10, 2017

One idea that keeps resurfacing in discussions on the defence budget is the creation of a non-lapsable defence modernisation fund (DMF) to harvest the money that remains unspent, especially under the capital segment, at the end of the financial year. In 2015-16, a sum of Rs. 85,894.44 crore was allocated for capital expenditure of the three services in the budget estimates (BE). The allocation was reduced to Rs. 74,299.61 crore at the revised estimate (RE) stage. Yet, at Rs. 71,675.43 crore, the actual expenditure was Rs 14,219.01 less than the initial allocation. Similarly, in 2016-17, the BE for capital expenditure of the three services was Rs. 78,586.68 crore, which was brought down to Rs. 71,700 crore at the RE stage. Assuming, for the sake of argument, that the actual expenditure will not be less than the RE, the underutilisation during the current year would amount to Rs. 6,886.68 crore.

The total unspent balance for these two fiscal years would work out to Rs. 21,105.69 crore. The argument advanced by advocates of the non-lapsable defence modernisation fund idea is that, had this amount been transferred to the fund, it alone would have been sufficient for signing contracts worth approximately Rs. 1,50,000 crore, since it is only the advance payment of 15 per cent that normally gets disbursed during the year in which a contract is signed. Further, going by back-of-the-envelope calculations, the amount available for signing new contracts in the next fiscal would be sufficient for signing contracts worth approximately Rs. 50,000 crore. Thus, in the coming year, the Ministry of Defence could sign contracts worth Rs. 2,00,000 crore, using the current allocation and the accumulation under the DMF, thereby giving a huge push to defence modernisation.

This prima facie makes for a persuasive argument for setting up a non-lapsable DMF. The question, however, is whether this is feasible and, more to the point, would it serve the intended purpose.

The idea of setting up a DMF has been around for more than a decade. There is a popular narrative that it has not been set up only because there is a marked reluctance on the part of the bureaucracy to amend the ‘rules of business’, dating back to the British era, which do not permit the setting up of such a fund. But the fact that Jaswant Singh, a former finance minister, had actually announced the setting of the fund in his interim budget speech on 03 February 2004 flies in the face of such a narrative. Yet, the myth persists. In fact, there is a plethora of evidence to show that the problem does not lie with any ‘rules of business’, which, in any case, can be, and have been, amended several times. As a matter of fact, a non-lapsable pool of resources for development of the north-eastern region has now been in operation for more than a decade. The problem, instead, lies with the merit and workability of the fund.

The objective of setting up a DMF is, apparently, to make sure that defence procurements do not suffer on account of shortage of funds. But, in the backdrop of perennial underutilisation of the capital outlay, it is a weak argument to assert that procurements are affected by shortage of funds.

Some would argue that underutilisation of funds is not for real and that it is the result of manipulation by the Ministry of Finance (MoF) which deliberately delays the process of financial sanction for individual procurement proposals. Here, it is important to note that proposals costing between Rs. 500 and 1,000 crore require approval of the finance minister and those above that limit require approval of the Cabinet Committee on Security (CCS), in which the finance minister is a member. The view is that the delays are caused either because of bureaucratic shenanigans or because the MoF needs to withdraw money at the RE stage to meet the fiscal deficit target. Assuming for the sake of argument that either or both of these reasons are valid, it is still difficult to visualise how these issues would be taken care of by the DMF, unless the role of the MoF and CCS in approving expenditure were to be eliminated simultaneously.

This can, of course, be done in relation to financial sanction for firmed up proposals before the signing of contracts by delegating full powers to the defence ministry. But even that would not solve the problem of the actual availability of funds. In addition, there can be no guarantee about the complete absence of problems in exercising delegated financial powers.

Be that as it may, there are two possibilities. One, that the unspent amount is withdrawn from the Consolidated Fund of India (CFI) and kept aside in some account to be used as and when required. The problem with this move, however, is that the government does not earn as much as it spends. It has to borrow to meet the expenditure year after year. Which implies that the amount in question, to be withdrawn and kept aside, would largely come out of borrowings. It would make little sense to borrow money, pay interest on it, and keep it idle till such time as the need arises for using it. For the record, while in 2015-16 interest payments accounted for Rs. 4,41,659 crore, in the coming fiscal the expenditure on this count is projected to be Rs. 5,23,078 crore.

The other possibility is that the unspent balance is rolled over to the next year and added to that year’s budgetary allocation to constitute a notional pool of funds, as it were, from which money could be withdrawn. Any such appropriation will require approval of parliament. More to the point, in the year the money lying idle in the DMF is to be used, the MoF will, in any case, have to raise it. It cannot do so as and when MoD asks for it during the year. It will have to be done necessarily as a part of the budgetary process in the beginning of the year. This effectively implies that MoD will have to project the requirement at the BE stage and the MoF will have to raise enough resources to allocate the sum asked for. And that brings the case for setting up a DMF back to square one.

The Standing Committee on Defence has been assiduously advocating the setting up of the fund despite being informed of the reasons why the idea was given up in 2004 itself. It has, in fact, advised the MoD “to process the creation of DMF with suitably changed modalities in Consultation with the Ministry of Finance so that the modernisation programme can be carried forward smoothly at the desired pace without any need to seek the Parliamentary approval again and again.”1

Apart from there being little discussion on what kind of changes need to be made, and whether there is enough justification to make the changes exclusively in respect of the defence budget, the question whether it will serve the intended purpose continues to be moot.

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