Budgeting for defence expenditure

Contemporary global challenges call for substantially increasing defence funding in India

In brief

• India’s external environment, especially in its neighbourhood, poses continuous defence challenges.
• There is a need to examine whether defence funding in India is adequate in the context of requirements for a Viksit Bharat.
• We assess whether defence needs have been adequately prioritized as the Government of India (GoI) fiscal space has remained constrained.

Benchmarking defence expenditure to 3% of GDP

To ensure adequate government budgeting for defence, the idea of benchmarking it to nominal GDP has been suggested time to time. Such benchmarking is likely to protect budgetary allocation for defence, and the Finance Commission (FC) may have to allow for the earmarked share for defence in their projections for GoI’s expenditures. The Parliamentary Standing Committee on Defence had, in its 35th Report (2022-23), recommended a benchmark of 3% of nominal GDP¹ for defence expenditure based on the ‘global ideal’ for defence expenditure. The report also highlighted concerns regarding the capacity of the defence establishment to fully absorb allocations upto 3% of GDP. However, in the context of Viksit Bharat and contemporary global challenges, it is important that government budget priorities are focused on augmenting defence expenditure by benchmarking its allocation up to 3% of GDP and focusing on India’s defence modernization and technological advancement of defence assets in a fast-changing global environment. This also implies that a faster growth in GDP would lead to larger allocation towards defence expenditure.

Why has India’s defence expenditure relative to GoI’s fiscal space fallen in recent years?

The reasons for the fall in Indian defence budget relative to GDP may be analyzed by examining trends in share of selected fiscal aggregates in GoI’s total fiscal space. GoI’s fiscal space may be considered as consisting of revenues from tax and non-tax sources, non-debt capital receipts and GoI’s annual borrowing prior to transfer to states.

Two important components of GoI’s expenditure relate to net interest payments and transfers to states. While the former has remained stable in the range of 18.1% to 18.5% of GoI’s total fiscal space over FC12 to FC15 periods (Table 1), the share of transfers to states (tax devolution and grants) shows a bulge in the FC14 period at 35.9%, rising from 25.4% in the FC11 period. Eventually, in the FC15 period this share came down to 32.4% owing to higher non-sharable cesses and surcharges which reduced the divisible pool.

The share of defence expenditures steadily fell from 17.0% in FC11 period to an average of 11.0% during the FC15 period. This fall, amounting to 6% points of GoI’s total fiscal space, almost mirrors the rise in the share of transfers to states which amounts to 7.0% points. 

Further, within defence expenditure, on trend basis, the share of defence capital expenditure has fallen while that of defence pensions has marginally increased. Any restructuring of defence expenditures should provide for a rising share of defence capital expenditures given the fast-evolving technological changes in the context of defence.

How additional fiscal space can be created to augment defence expenditure?

Growth in total defence expenditure exhibits a volatile pattern (Chart 2).

This volatility may be overcome by a non-lapsable defence fund so that budgetary expenditure allocated for defence does not lapse. The GoI had recognized this issue earlier and an additional Terms of Reference (ToR) was given to FC15 in this context. The FC15 recommended that the GoI may constitute in the Public Account of India, a dedicated non-lapsable fund called Modernisation Fund for Defence and Internal Security (MFDIS), to bridge the gap between projected budgetary requirements and budget allocation for defence and internal security. The fund was proposed to be financed by

• Transfers from the Consolidated Fund of India
• Disinvestment proceeds of Defence Public Sector Enterprises
• Proceeds from the monetization of surplus defence land 
• Proceeds of receipts from defence land likely to be transferred to state governments and for public projects in future. In fact, even private contributions may be allowed for this purpose.

However, this defence fund has not been operationalized as yet.

It is time to re-examine the issue, recognizing that defence needs arise suddenly and in unanticipated ways and call for steady and assured buildup of capacities over time.

In the history of FC recommendation-based funding mechanisms, there is already a precedent for this in the form of the National Calamity Contingency Fund (NCCF). This fund was justified on the following grounds:

1. Inadequacy of normal budgetary allocation
2. Unanticipated shocks subject to expenditure shocks
3. Shared responsibility of GoI and states
4. Need for constant replenishment of funds
5. Non-lapsable nature of need

These arguments hold for defence expenditure also. There may thus be a case for creating a non-lapsable defence fund, particularly for purchase and maintenance of defence capital goods and for research and innovation.

Maximizing multiplier effects of government defence expenditure with Aatmanirbhar strategy

Various studies estimate the multiplier of an increase in defence expenditures at less than one. It is only in some contexts pertaining to developed countries that the multiplier of defence expenditure is higher than one. In India, not many multiplier estimates pertaining specifically to defence expenditure are available. Multiplier effects are likely to be lower in a country where most of the procurement of defence capital goods are from abroad. However, the magnitude of defence capital expenditure multiplier can be increased if defence capital assets are produced domestically and when private sector participation is encouraged.

Since India has now embarked upon an Aatmanirbhar strategy and is also expanding the role of private sector in the production of defence capital assets, we may expect increasing income and employment multipliers associated with defence investment in India.

India’s defence expenditure excluding pensions relative to GDP has fallen over time from 3% in the initial years of the decade of 2000s to 1.87% as per FY26 (BE) with a peak of 2.91% in FY03. There are also large annual variations in the pattern of growth of different components of defence expenditure. To ensure a minimum budgetary allocation for defence, it may be earmarked to 3% of GDP on an annual basis and this may be accounted for by FC16 while determining the share of states in GoI’s divisible pool of taxes. Further, given the lumpy and volatile nature of some dimensions of defence expenditure, it is best to supplement this benchmarked defence allocation in the central Budget with the mechanism of a non-lapsable defence fund.