THE CONTEXT: India’s fiscal landscape faces challenges as the government grapples with high debt-to-GDP ratios and fiscal deficits. The 2024-25 Union Budget outlines a plan to reduce the fiscal deficit to 4.5% of GDP by 2025-26, but concerns remain about the sustainability of this approach and its impact on private sector investment.
PRESENT FISCAL HEALTH OF INDIA:
- High Fiscal Deficit and Debt Levels: The Centre’s debt-GDP ratio is estimated to be 54% in 2025-26, significantly higher than the 40% target set by the Fiscal Responsibility and Budget Management (FRBM) Act of 2018.
- Limited Investible Surplus: Household financial savings have decreased to 5.3% of GDP in 2022-23, compared to an average of 7.6% in the previous four years (excluding 2020-21).
- High-Interest Payments: The ratio of the Centre’s interest payment to revenue receipts (net of tax devolution) has increased to an average of 38.4% from 2021-22 to 2023-24, up from 35% in 2016-17. When considering all transfers, including tax devolution and grants, this ratio averaged 51.6%.
- Asymmetric Adjustment of Debt-GDP Ratio: The COVID-19 pandemic caused the central debt-GDP ratio to increase rapidly from 50.7% in 2019-20 to 60.7% in 2020-21.
PERSISTENT VICIOUS CYCLE:
- High Debt-to-GDP Ratio and Fiscal Deficit: The high debt and deficit levels challenge fiscal sustainability and limit the government’s ability to respond to economic shocks or increase developmental spending. India’s fiscal deficit is around 9% of GDP, compared to an average of 5% for emerging markets.
- Crowding Out of Private Investment: High government borrowing can crowd out private investment. With household financial savings dropping to 5.3% of GDP in 2022-23 (compared to 7.6% in previous years) and the government’s fiscal deficit at 7.5%, a limited investible surplus remains for the private sector.
- Limited Fiscal Space for Countercyclical Policies: The high debt and deficit levels reduce the government’s ability to implement countercyclical fiscal policies during economic downturns. The business cycle fluctuations explain a smaller fraction of debt variation in India compared to peers, reaffirming limits to countercyclical fiscal policy.
- Vulnerability to Economic Shocks: While India’s debt is largely domestically held and long-term, reducing some risks, the high debt level makes the economy more vulnerable to shocks. For instance, the COVID-19 pandemic caused the central debt-GDP ratio to spike from 50.7% in 2019-20 to 60.7% in 2020-21.
- Challenges in Fiscal Consolidation: Fiscal consolidation would require lowering primary deficits through increased tax revenue generation and measures like privatization. However, implementing such measures can be politically challenging and may face resistance.
- Higher Cost of Capital: As savings decline, the cost of capital tends to rise, making investments more expensive for the private sector. This can discourage private investment, especially in capital-intensive sectors.
- Impact on Long-term Growth: Low savings can hamper long-term economic growth A positive correlation exists between savings rates and economic growth in developing countries. China’s high savings rate (around 45% of GDP) has been a critical factor in its rapid economic growth. It has allowed for high levels of domestic investment without excessive reliance on foreign capital.
THE WAY FORWARD:
- Gradual Fiscal Consolidation: India needs to gradually reduce its fiscal deficit and debt levels without hampering growth. Focus on improving the efficiency of government spending rather than making broad cuts. Prioritize productive capital expenditures over revenue expenditures. Widen the tax base, improve tax compliance, and rationalize tax exemptions. Through spending cuts and tax reforms, Canada reduced its debt-to-GDP ratio from 67% in 1995 to 28% in 2008.
- Boost Economic Growth: Higher economic growth is crucial for debt sustainability. India should aim for 7-8% real GDP growth. Continue reforms in labor laws, land acquisition, and ease of doing business to boost private investment. Increase public investment in infrastructure to crowd-in private investment. The National Infrastructure Pipeline, with a planned investment of ₹111 lakh crore over 5 years, is a step in this direction.
- Promote Household Savings: To reverse the declining trend in household savings, more tax-efficient long-term savings products should be introduced. Enhance awareness about the importance of savings and various investment options. Maintain price stability to protect real returns on savings. Singapore’s Central Provident Fund (CPF) system mandates savings for retirement, healthcare, and housing, resulting in one of the highest savings rates globally.
- Improve Debt Management: Increase the average maturity of government debt to reduce rollover risks. Attract more foreign investment in government bonds to reduce dependence on domestic banks. As of 2021, the average maturity of Indian government securities was 11.3 years. Extending this further can enhance debt sustainability.
- Enhance Public Sector Efficiency: Continue with strategic disinvestment of public sector enterprises to improve efficiency and generate resources. Leverage private sector efficiency in public projects.
- Address Contingent Liabilities: Address the financial health of power distribution companies to reduce contingent liabilities. Incentivize fiscal discipline in states through performance-linked transfers. Combined state government debt has risen from 21% of GDP in 2011-12 to 31% in 2021-22, highlighting the need for state-level fiscal reforms.
- Enhance Productivity of Public Spending: Link budget allocations to measurable outcomes—leverage technology to better target subsidies and reduce leakages. The Direct Benefit Transfer (DBT) scheme has helped save over ₹2.2 lakh crore by reducing leakages and improving targeting of subsidies.
THE CONCLUSION:
To address these fiscal challenges, it is recommended that the central government adhere to a 3% GDP limit for fiscal deficit, with a clear roadmap to achieve this target. Relaxing this rule may lead to budgetary imprudence and hinder private sector investment growth, especially given the current lower levels of household financial savings.
UPSC PAST YEAR QUESTIONS:
Q.1 What are the reasons for introduction of Fiscal responsibility and Budget Management (FRBM) act, 2003? Discuss critically its salient features and their effectiveness. 2013
Q.2 Among several factors for India’s potential growth, savings rate is the most effective one. Do you agree? What are the other factors available for growth potential? 2017
MAINS PRACTICE QUESTION:
Q.1 India’s household net financial savings have fallen to a multi-decade low, while household debt has risen significantly. Examine the macroeconomic implications of this trend and suggest measures to address the challenges it poses for sustainable economic growth.
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