Improving conditions

Govt must present a revised fiscal glide path

The allocation of key portfolios in the third Narendra Modi government indicates continuity in policy. This should give confidence to financial markets, which became a bit jittery after the election results. However, while broad continuity will help boost confidence in the short run, policy needs to evolve with changing circumstances. In this context, Union Finance Minister Nirmala Sitharaman would be expected to build on the foundations of recent years. Her previous term was perhaps the most difficult that a finance minister has faced in recent memory, largely because of the pandemic-related shocks. Even though India managed a strong recovery from the pandemic, ongoing efforts will be needed to sustain growth and repair the country’s fiscal position. The Indian economy expanded 8.2 per cent in 2023-24 and is broadly expected to grow at about 7 per cent this financial year.

On the fiscal front, the government seems on course to achieve the medium-term fiscal deficit target of 4.5 per cent of gross domestic product (GDP) in 2025-26. Higher than expected revenue collection and economic growth brought down the fiscal deficit to 5.6 per cent last financial year, compared to the Interim Budget’s revised estimate of 5.8 per cent. For the current year, a higher than expected surplus transfer by the Reserve Bank of India (RBI) will help government finances. As Ms Sitharaman and her team begin preparing the full Budget — expected in July — they would be well advised to use the additional surplus transfer by the RBI to reduce the fiscal deficit and take it close to the medium-term target. Given the new political landscape, there is likely to be pressure for additional spending.

However, the government should not give up the hard-won fiscal gains of the past few years. In fact, it would be well advised to present a revised fiscal glide path to bring down the fiscal deficit to 3 per cent of GDP. This will be important for bringing down the debt-to-GDP ratio to a more manageable level. According to the International Monetary Fund projections, India’s general government debt is expected to remain above the pre-pandemic level at least till 2029. In terms of augmenting revenue, the Union government should immediately initiate the process of rationalising rates and slabs of goods and services tax (GST) in the GST Council. This will not only help boost revenue collection but also improve the ease of doing business.

One of the possible challenges in bringing down the fiscal deficit would be its implication for growth. Economic growth in the post-pandemic period has been largely driven by government capital expenditure. With sustained fiscal consolidation, the private sector will need to fill the investment gap. However, the private sector seems hesitant to significantly expand capacity, arguably due to weak domestic demand. While demand in rural India is expected to revive with a normal monsoon, India should also focus on catering to global demand. The government has increased tariffs in recent years, which affects external competitiveness. While the finance ministry must now review the effectiveness of higher tariffs in achieving higher sustainable growth, attracting investment and driving growth will require a whole-of-government approach. The first full Budget of the new government will be keenly watched for signals as to how the government intends to take the Indian economy forward.