India needs fiscal space, not just subsidies, to weather crises

Finance Minister Nirmala Sitharaman has asked everyone to focus on three Fs — foreign exchange, fuel, and fertiliser — to deal with the current crisis. But she might wish to add another key F: Fiscal space. If available, that would have given her more room for manoeuvre in addressing the current crisis.

 

If India had created more fiscal space in the three good years following the end of the Covid crisis in 2022-23, it would have more options to deal with the current one. In my January 2025 column, I warned that unless India was able to create greater fiscal space during favourable times, we would not have any powder to deal with the next crisis. That warning went unheeded and here we are with a crisis no one anticipated and for which India is badly unprepared with only limited options at its disposal.   

The glide path that India has followed in reducing the fiscal deficit has been too slow. Its fiscal deficit in FY27 (Budget Estimate) is projected at 4.3 per cent of gross domestic product (GDP) after a slow glide, which brought the central fiscal deficit down to 4.4 per cent of GDP in FY26 (see chart), from 6.7 per cent in FY22.  

Together with the fiscal deficit of the states, which increased in FY24 and  FY25, this meant that public debt, as a share of GDP, declined very slowly and has  remained above 80 per cent of GDP. Even before the West Asia crisis, the debt was projected to fall below 80 per cent of GDP only in 2030. This must be one of the slowest fiscal corrections after a crisis, creating more financial repression to finance deficits and keeping commercial interest rates elevated (Agarwal and Vardhan)1.   

Two obvious areas for reducing the fiscal deficit faster would have been faster privatisation, which has gone moribund since the much-heralded Air India sale. Except for the Maharatnas, which serve a strategic purpose, in a detailed study I did at the National Institute of Public Finance and Policy  some years ago2, I argued that there was no reason to hold on to so many public-sector enterprises (PSEs) and to use the sale proceeds to finance public infrastructure. But since then, India has already invested considerably in public infrastructure, so proceeds of future PSE sales should be used to reduce public debt and create fiscal space for future crises. 

In fact, since then, the number of PSEs in India has surprisingly gone up instead of going down — strange for a government that started with the slogan “Maximum Governance, Minimal Government”. Selling a large chunk of these companies to pare down the public debt would create the fiscal space that we need to handle future crises — too late for this crisis, but needed for the next one. 

The other would have been to address another F — namely “freebies”. Every state and general election throws up more freebies. The biggest freebie is the Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY), which provides free food to 814 million citizens (56 per cent of the population), costing 0.7 per cent of GDP, but whose costs will now rise to above 1 per cent of GDP. 

At the recent ET Global Summit, Prime Minister Narendra Modi explained his reasoning for giving such a large subsidy not just to the 200 million below the poverty line, but also to another 600 million whom he classified as being just above the poverty line and who could fall back into poverty, and therefore deserve free food. 

But one wonders where all this free food goes. According to Santosh Mehrotra, former professor at Jawaharlal Nehru University, the just-released Sixth National Family Health Survey shows that India’s child malnutrition rate was a substantial 32 per cent in 2023-24 — almost unchanged from 2019-21 (NFHS-5). 

The real reason for this extraordinary largesse is that he is unable to ensure jobs for so many people and provides them with this huge “freebie” to get their vote. Now every party in every election vies with one another to provide more freebies, leading to bigger central and state-level deficits. State-level deficits increased sharply in FY24 and FY25, contributing to keeping public debt levels high.  

But given the lack of fiscal space, and rising fertiliser subsidies, the government will have no choice but to increase prices for fuel and cut back on other expenditure, including its capital expenditure. Monetary policy is also constrained by the rapidly depreciating rupee and the huge surge in inflation likely to come.  

The latest survey shows that business inflation expectations done for March 2026 increased by 57 basis points, from 5.07 per cent to 5.64 per cent. Firms held their inflation expectations at over 5 per cent for three consecutive months — a phenomenon witnessed only after August 2022. Businesses in April 2026 expected one year ahead Consumer Price Index headline inflation to be at 4.94 per cent, up by 24 bps from 4.7 per cent reported in February 2026.  

The Monetary Policy Committee will be under pressure to raise interest rates — no relief there. There are cries to constrain capital outflows to manage the falling rupee. But this could hurt India even more in the longer run. The only option will be greater credit forbearance to help small firms already hit hard by rising gas and fuel prices to survive until the end of this crisis. 

The Reserve Bank of India extended an enhanced credit period of up to 450 days for both pre-shipment and post-shipment export credit  disbursed until June 30, 2026. The government has announced a ₹2.5 trillion credit forbearance scheme — especially for micro, small and medium enterprises.   

But a big lesson from this crisis is that, especially as global uncertainty rises, India should expect more crises in future, and the best way to deal with them is to have the fiscal space to respond when they do arise. This is the critical F the FM should focus on in future. 

The author is distinguished visiting scholar, Institute for International Economic Policy, George Washington University

1. Why commercial credit remains expensive in India 

2. http://www.nipfp.org.in/publications/working-papers/1776