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Context:
Government expenditures exceeding revenue by a high margin can lead to a difficult situation.
India’s high debt analysis: https://www.iasgyan.in/daily-current-affairs/high-government-debt
Article highlights:
- In the 1980s, a rising fiscal deficit accompanied by rising government debt led to a difficult balance of payments situation and a high ratio of interest payments to revenue receipts.
- This forced the government to borrow progressively more to meet developmental expenditures.
- The final 2024-25 Union Budget highlighted the need for reducing the fiscal deceit from 2026-27 onwards, such that the Central government debt will be on a declining path as a percentage of GDP.
- The Budget speech of the union finance minister said that the Centre’s fiscal deficit would be reduced to 4.5% of GDP in 2025-26 from its budgeted level of 4.9% in 2024-25. This is not in consonance with FRBM targets to be reached by 2018.
The Fiscal Responsibility and Budget Management (FRBM) Act of 2003
It was enacted to ensure fiscal discipline in India.
The 2018 amendment to the act set the following targets for the financial year 2017-18:
- Eliminate Effective Revenue Deficit (ERD): The ERD was to be eliminated by March 31, 2018.
- Reduce Revenue Deficit (RD): The RD was to be contained at 2% of Gross Domestic Product (GDP) by March 31, 2018.
- Reduce Fiscal Deficit (FD): The FD was to be contained at 3% of GDP by March 31, 2018.
- The FRBM Act also incorporated the concept of "General Government debt", which includes both Central and State Government debt. The act set a target of containing General Government debt at 60% of GDP by the end of the financial year 2024-25.
For further reading on FRBM refer to the following article:
https://www.iasgyan.in/daily-current-affairs/fiscal-deficit-37#:~:text=Key%20features%20of%20the%20FRBM%20Act&text=The%20FRBM%20Act%20proposed%20that,medium%2Dterm%20fiscal%20policy%20statement
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Fiscal Consolidation and Debt Management in India:
Inadequate Fiscal Consolidation:
- Fiscal consolidation is essential for maintaining sustainable government debt levels and avoiding excessive borrowing.
- By aiming for a decreasing debt-to-GDP ratio, the government strives to stabilise fiscal policies and ensure macroeconomic stability. However, due to inadequate fiscal consolidation, the debt-to-GDP ratio is high in India.
- The country's external debt to GDP ratio declined to just 18.7 per cent at the end of March 2024 from 19 per cent at the end of March 2023.
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Fiscal consolidation is a set of policies that governments use to reduce their debt and deficits. These policies can be implemented at the national or sub-national level.
Fiscal consolidation aims to reduce government debt and deficits, but it doesn't aim to eliminate them.
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Debt-to-GDP Ratio and Fiscal Deficit:
- The current fiscal deficit target is set at 4.5% of GDP. While this target helps manage the debt-to-GDP ratio, it lacks specific long-term goals.
- This could result in a gradual reduction of the debt-to-GDP ratio over time without immediate, strict targets.
Current trajectory
- India's debt-to-GDP ratio increased significantly during the COVID-19 pandemic. Returning to pre-pandemic levels is proving difficult.
- The current adjustment path shows challenges in quickly reducing debt while handling substantial interest payments.
Impact on Private Sector and Savings:
- High fiscal deficits can limit the available investible surplus for the private sector.
- As household financial savings decrease, high deficits may crowd out private-sector investments, potentially restricting economic growth.
Way Forward:
Fiscal Consolidation:
Target a total general government debt-to-GDP ratio of 60% overall (40% for central government, 20% for states) as per the NK Singh Committee should be met.
State-Level Fiscal Reforms:
Encourage states to adopt prudent fiscal policies by offering rewards for fiscal discipline and limiting excessive borrowing.
Revenue Enhancement:
- Tax Collection & Compliance: Improve tax administration and leverage technology to reduce evasion. GST Network (GSTN) and faceless tax assessment are such examples.
- Administrative Streamlining: Optimise revenue through better administration of existing and new taxes. Implementing systems like the Taxpayer Identification Number (TIN) in the UK to simplify tax collection and compliance.
Spending Re-orientation:
- Infrastructure Investments: Prioritise spending on physical infrastructure, human capital, and green projects.
- Privatise Loss-Making PSUs: Consider privatising loss-making public sector undertakings.
- PPP Models: Implement public-private partnerships in social schemes to alleviate public debt.
Institutional Mechanisms:
- Public Financial Management System (PFMS): Fully leverage PFMS for enhanced transparency and accountability.
- Public Debt Management Agency (PDMA): Establish PDMA to centralize expertise and improve public debt management strategies.
Conclusion:
For sustainable economic growth, India must aim for a fiscal deficit of 3% of GDP. Establishing a clear plan to reach this target is crucial to prevent fiscal mismanagement and to maintain investor trust.
Important articles for reference
Fiscal deficit
https://www.iasgyan.in/daily-current-affairs/types-of-deficits
Fiscal Goals
https://www.iasgyan.in/daily-current-affairs/fiscal-goals
Debt to GDP ratio
https://www.iasgyan.in/daily-current-affairs/high-government-debt
Sources:
https://www.thehindu.com/opinion/lead/stick-to-fiscal-deficit-as-the-norm-for-fiscal-prudence/article68614653.ece
https://m.economictimes.com/markets/expert-view/budget-will-be-aligned-with-bjps-thrust-on-gyan-strategy-capex-growth-pace-may-slow-slightly-in-fy25-sonal-varma-nomura/articleshow/107234567.cms
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PRACTICE QUESTION
Q. Economists have cautioned that high debt-to-GDP ratio might distort the macroeconomic outcomes in India. In this context analyse the reasons for high debt-to-GDP ratio in India. Also discuss its repercussions on the Indian economy and ways to manage these issues. ( 250 words)
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