Higher capital spending is good, but fiscal prudence is essential

The way government finances are managed in any country has a significant bearing on its long-term growth and development. At India’s current stage of development, government support is necessary in various aspects, including the development of social and physical infrastructure. However, there are Budget constraints and the government has many other demands on its finances, including the cost of its own functioning, and it is important to keep a balance. It is also crucial that the Budget is balanced and that the government does not rely on borrowing excessively to fulfil its obligations. In this regard, a new research article by economists at the Reserve Bank of India, published in the latest Monthly Bulletin, maps the quality of government expenditure at both central and state levels since 1991, highlighting significant improvement.

 

While there are various ways of looking at the quality of public expenditure, two important indicators are the amount of capital expenditure by the government and the ratio of revenue expenditure to capital outlay (Reco). An increase in capital outlay results in an expansion in overall investment, leading to better growth outcomes over time. The multiplier effect associated with capital expenditure is not only higher than revenue expenditure but also lasts for a longer period. A shift in favour of capital expenditure can help improve growth outcomes in a sustainable manner. While these conditions are well known, it is not always easy for the government of the day to push capital expenditure because of various constraints. In the initial years of economic reforms, which began in 1991, the capital outlay of the Union government declined from 1.7 per cent of gross domestic product (GDP) in 1991-92 to 1.2 per cent in 1995-96. Despite the government’s efforts to control expenditure, the outgo in interest payments remained high. Even in the next phase till the implementation of the Fiscal Responsibility and Budget Management Rules, capital expenditure remained subdued.

 

Fiscal reforms enabled a shift, increasing the Centre’s capital outlay from 1.2 per cent of GDP in 2003-04 to 2.2 per cent in 2007-08. The Reco ratio also fell sharply. Capital spending in states also increased during this period. After this period, the focus shifted to support measures owing to the global financial crisis of 2008. Between 2013-14 and 2019-20, the central capital outlay stayed between 1.3 per cent and 1.6 per cent. The focus shifted decidedly to capital expenditure after the pandemic. The increased capital expenditure helped the Indian economy recover from the pandemic-induced disruption. The Union government’s effective capital expenditure — including allocations of grants-in-aid to create capital assets — was pegged at 4.6 per cent of GDP in 2024-25 (Budget Estimate). The study also finds that the quality of expenditure at state level is positively related to health and educational outcomes.

 

While the quality of expenditure has improved in recent years, there are concerns related to fiscal management, which must be addressed. General government debt, for instance, remains on the higher side. Thus, to sustain capital-expenditure momentum, the government needs to boost revenue collection. The impending rate rationalisation in goods and services tax could be one option. Further, despite several years of high capital expenditure, a pickup in private investment remains lacklustre. The government would do well to address the concerns of businesses to boost confidence. A pickup in private investment will ease pressure on government finances. Finally, the trend of populist schemes — particularly in states, because of political compulsions — is worrisome and runs the risk of undoing fiscal gains. India needs a wider political consensus to address this issue.