India needs planned deregulation to reduce government size, expenditure

The combined expenditure of the Centre and state governments increased hugely in 1980s-by almost 10% of gross domestic product (GDP) to 27 per cent of GDP by 1991, and has remained high since then

As Donald Trump generates global uncertainty and dismantles India’s tariff regime with a “reciprocal tariff” gun, the time to improve competitiveness by reducing red tape, corruption, and bureaucracy has come. Alongside the deregulation announced in the Budget, India must reduce the size of government — fulfilling the “Maximum Governance, Minimal Government” (M2G2) promise that Prime Minister Narendra Modi first made in 2014.

 

The combined expenditure of the Centre and state governments increased hugely in the 1980s—by almost 10 per cent of gross domestic product (GDP) to 27 per cent of GDP by 1991, and has remained high since then. Today, government spending at almost 28 per cent of GDP is the same as in South Korea and well above other Asian competitors like Thailand, Indonesia, and Vietnam. This has been so for the last 30-odd years (see Chart 1). Even in China and South Korea, public spending was below 20 per cent of GDP during their periods of explosive growth and has risen only recently. Fiscal discipline has been a less publicised but critical hallmark of East Asian economic success.

 

Some experts cite India’s low tax-to-GDP ratio to argue that the government size is too small rather than too big. But at India’s income level, a tax-to-GDP ratio of 18.6 per cent in 2024-25 is not low, and the total revenue-to-GDP ratio is even higher at 22 per cent. They also cite the need for more teachers, health workers, technical staff, and even foreign service officers. All this is true, but this does not mean more government spending. Instead, it calls for reducing the large number of non-technical office workers and reallocating those funds to hire more technical personnel. It also requires that more of this hiring be done at the local level rather than at the central or state level, where pay scales are much higher.

 

India’s huge government spending has led to large fiscal deficits (see Chart 2). Since 1990-91, the combined fiscal deficit of the Centre and the states has averaged a whopping 7.8  per cent of GDP. Fiscal dominance has compelled the Reserve Bank of India to keep government borrowing costs low through the arcane instrument of the statutory liquidity ratio (SLR), which forces commercial banks to buy government bonds. It has been as high as 39.5 per cent in the past, and remains at 18 per cent today. The only other country that still uses SLR is Bangladesh — where it stands at 13 per cent. This financial repression helps finance the fiscal deficit but at a huge cost to the development of a commercial bond market and the availability of domestic capital for the private sector — especially micro, small and medium enterprises (MSMEs).

 

India’s public debt at 82 per cent of GDP is exceedingly high and its proposed reduction by 2030 to 70 per cent of GDP is quite slow and dependent on optimistic growth projections. The public capex push has plateaued, and India will have to increase defence spending as the rest of the world rearms. Meanwhile, the Trump-induced tariff reduction, though good for the Indian economy overall, will have an immediate impact of lowering tariff revenue. India needs to free up fiscal space through government reform and accelerated privatisation. Inexplicably, privatisation has stalled since the sale of Air India.

 

India does not need a DOGE—dismantling of government with indiscriminate cuts, as Elon Musk has unleashed on the US government — but a more carefully planned approach, like the Reinventing Government initiative led by Vice-President Al Gore from 1993-96 in the Clinton administration, whose budget surpluses famously led to a huge reduction in public debt. The administrative reforms China conducted in 1995-96 under Premier Zhu Rongji to modernise the Chinese government for the 21st century are also worth studying.

 

Successive pay commissions — especially the seventh — have handed out large emolument increases and pensions and reduced the gap between the upper and lower pay scales. As a result, lower-level government employees receive pay packages far more than their private sector counterparts. No wonder that government jobs are so sought after. And the newly announced 8th Pay Commission is expected to increase these wages and pensions further. Without serious administrative reforms, these pay hikes will only deepen the damage to the government’s fiscal health.

 

With more than 60 per cent of public spending in state hands, administrative reforms must also be implemented at the state level. Instilling fiscal discipline in wayward states is not easy, especially since they can finance their deficits at the same borrowing rate as fiscally responsible states due to their debt being guaranteed by the Centre. This must be addressed to ensure that profligacy is punished, not rewarded. The 16th Finance Commission must also focus — even more than past commissions — on incentives that can encourage greater fiscal discipline in the states.

 

The NITI Aayog has created a new fiscal health index to identify which states are doing better in fiscal management. But as Govinda Rao pointed out in this newspaper, it needs further improvements. The high rating given by the fiscal health index to states like Odisha, Jharkhand, and Chhattisgarh, despite shortfalls in teachers and health workers, indicates that, besides fiscal rectitude, the effectiveness of service provision must also be a crucial factor in a fiscal health index.

 

The Skoch Group’s latest report, titled State of Governance Transformation1, which measures technical governance — comprising internet penetration, education enrolment, and provision of online services, as well as the quality of project implementation—shows that Jharkhand and Chhattisgarh score very low on this index. While Odisha has shown improvement, its overall score remains below the national average. Assam and Bihar also scored very poorly. Andhra Pradesh, Telangana, Gujarat, Maharashtra, and West Bengal performed the best.

 

The time to act more boldly to enhance India’s competitiveness has come. The heavy burden of bloated government expenditure, excessive controls, and complex regulations is like trying to run a marathon with a heavy weight tied to your leg. Without M2G2, India cannot complete the race to a Viksit Bharat.   

 

The author is distinguished visiting scholar, George Washington University, and distinguished fellow, Ashoka University  1.  State of Governance: Transformation in Indian States - 2014-2024 | SKOCH Development Foundation - Catalysing Livelihoods