(General Studies III – Fiscal Consolidation – Indian Economy and issues relating to planning, mobilization, of resources, growth and development)
- Fiscal consolidation involves policies aimed at reducing government deficits and debt accumulation.
- It is essential for economic stability, especially when government expenditures significantly exceed revenues.
- In the 1980s, rising fiscal deficits and government debt led to a balance of payments crisis, emphasizing the need for sustainable fiscal management.
Current Fiscal Situation –
- 2024-25 Union Budget: A target to reduce the fiscal deficit to 4.5% of GDP by 2025-26.
- Debt-to-GDP Ratio: Expected to be 54% by 2025-26, with plans to further reduce this ratio.
- Long-Term Goal: A continued path of reducing debt-to-GDP, with an estimated 48% by 2048-49.
- FRBM Act (2018): Previously set a target of 40% debt-to-GDP ratio for the Central government.FRL Framework (2003) established debt and fiscal deficit levels combinations to maintain fiscal discipline.
- New Approach: Focus on a stable 4.5% fiscal deficit while gradually reducing the debt-to-GDP ratio.While effective in reducing debt, this could limit private sector investment space unless household savings increase.
Reasons behind Increased Fiscal Deficit –
- The government has ramped up spending on infrastructure, healthcare, and social welfare programs to stimulate growth and address societal needs, often outpacing revenue generation. E.g. COVID-19 Pandemic increased India’s central debt-to-GDP ratio from 50.7% to 60.7% in 2020-21.
- Asymmetric adjustment returning to pre-shock debt levels is slow, with governments often delaying debt reduction while managing high-interest payments.
- Even before the pandemic in response to slow growth rate, reduced tax rates and ineffective tax collection have decreased government revenue.
- Narrow Tax Base: A limited tax base, especially in the informal sector, results in insufficient revenue generation.Sluggish economic growth leads to reduced tax revenues.
- Inflationary Pressures: High inflation increases government spending on subsidies, further widening the deficit.
- Heavy Reliance on Borrowing: The government frequently borrows to finance deficits, leading to increased debt and interest rates.
Impact of High Fiscal Deficit –
- Crowding Out Effect: Government borrowing can limit private sector investment by raising interest rates. E.g. Household Savings dropped from 7.6% to 5.3% of GDP in 2022-23. The fiscal deficit of central and state governments absorbs nearly all available investible surplus.
- High debt levels lead to increased interest payments, which reduce funds for developmental expenditures. E.g. developed countries like Japan, the UK, and the US have much higher debt-to-GDP ratios but much lower interest payment-to-revenue ratios (5.5% – 8.5%).India’s combined interest payments average 24% of revenue receipts, with the Centre’s ratio at 49%, indicating constrained fiscal space.
- In the short term, a fiscal deficit can stimulate economic activity. Governments often increase spending during recessions to boost demand, which can lead to job creation and infrastructure development.
- Inflation: Persistent fiscal deficits can lead to inflation, particularly if financed by borrowing from the central bank. This can increase the money supply, resulting in higher prices and reduced purchasing power for consumers.
- Higher Interest Rates: A significant fiscal deficit may lead to higher interest rates.
- Debt Burden: Continuous fiscal deficits contribute to a rising national debt, which poses a burden on future generations.
- Balance of Payment Issues: Large fiscal deficits may necessitate borrowing from foreign sources, leading to a decrease in foreign exchange reserves and potential balance of payments problems. This can further destabilize the economy and lead to currency devaluation
| The Indian central government has implemented several measures to reduce the fiscal deficit in recent years. Here are the key steps taken – • Revised Fiscal Targets: The government has set a specific fiscal deficit target of 5.6% of GDP for FY24, down from a previous estimate of 5.8%. • Improved Tax Collections: The government has focused on enhancing tax revenue, with net direct tax collections growing by 17.7% year-on-year, reaching Rs 19.58 lakh crore in FY24. • Expenditure Rationalization: The total expenditure for FY24 was kept at 99% of the targeted amount, with a significant portion directed towards capital spending on infrastructure projects, which is expected to yield long-term economic benefits. • Reduction in Subsidies: The government has aimed to lower spending on subsidies, creating fiscal space to meet deficit targets. This strategy is expected to contribute to a more sustainable fiscal position. • Support from the Reserve Bank of India (RBI): The RBI has contributed significantly to the government’s finances, transferring Rs 87,416 crore as surplus, which has helped bolster fiscal resources. |
India’s fiscal consolidation requires balancing fiscal prudence with developmental needs. Sustained fiscal consolidation, which supports a downward trajectory in the government debt ratio over the medium term would be supportive of India’s credit profile, particularly when combined with the current positive momentum on macroeconomic performance and external finances. A clear roadmap for fiscal consolidation will help ensure economic stability, allowing for private sector growth and fostering a resilient fiscal framework for the future.
