Fiscal clarity needed

India needs medium-term targets

The Union government did well to partly use the improved revenue position to project a lower fiscal deficit for this financial year. It will now target containing the fiscal deficit at 4.9 per cent of gross domestic product (GDP) this financial year compared to the target of 5.1 per cent announced in the Interim Budget. The government is following a glide path announced in 2021 to bring down the fiscal deficit to below 4.5 per cent of GDP by 2025-26. It is on course to attain the target next year. In this context, financial markets and analysts were expecting the Union Budget to present a revised medium-term fiscal path. Union Finance Minister Nirmala Sitharaman, however, announced that from 2026-27 onwards, the government would maintain the fiscal deficit in such a way that the central-government debt remains on a declining path as a percentage of GDP.

The post-Budget media interaction of the finance minister and senior officials in the finance ministry, including with this newspaper, suggests that the government doesn’t want to subject itself to specific targets and work according to evolving economic conditions. The government, however, would be well advised to provide more clarity. To be fair, focusing on debt is perfectly justified. In fact, the Fiscal Responsibility and Budget Management (FRBM) Act expected general government debt to be limited to 60 per cent of GDP, with central government debt at 40 per cent of GDP, by March 2025. As the statements of fiscal policy in the Budget documents note, the fiscal deficit is only an operational target.
 

Given that central-government debt this financial year is expected to be 56.8 per cent of GDP, it is important for stakeholders to know what level the government will be targeting, say, over the next five years. It would also be important to know the required level of fiscal deficit to attain the desired amount of debt in the given timeframe. Thus, the fiscal deficit over the medium term and debt are not independent of each other. At this stage of development, when both the government and the private sector need to raise money for investment — including from global markets — having a transparent and rule-based fiscal framework will help. It has also been the basic essence of the FRBM Act. A rule-based fiscal framework will also help rating agencies in assessing India.
 

Further, the ability of the economy to finance the fiscal deficit is missing from the conversation. Net household financial savings fell to a multi-decade low of 5.3 per cent of GDP in 2022-23. Even if it rebounds to the average of about 7.5 per cent of GDP seen over the past decade, it would entirely be going to fund the general government Budget deficit, leaving practically nothing for the private sector. It is well accepted that the revival of private investment is critical for sustaining higher growth over the medium to long term. The desired level of fiscal deficit in the FRBM rules was also based on the availability of financial savings in the economy. Sustained higher deficits for extended periods carry a real risk of crowding out private investment, thereby affecting the long-term potential of the economy. The government thus needs a revised fiscal framework consistent with underlying economic growth, debt sustainability, and availability of financial savings in the economy.