Debt management: India must focus on sustained fiscal consolidation

One of the highlights of the Union Budget 2025-26, presented by Finance Minister Nirmala Sitharaman last week, was the continuance of credible fiscal management. The government aims to restrict the fiscal deficit to 4.8 per cent of gross domestic product (GDP) this financial year, improving upon the Budget Estimate of 4.9 per cent, despite lower than expected nominal GDP growth. While it is correct that a lower outgo on capital expenditure, partly because of the restrictions related to the general elections, helped contain the deficit, it must be recognised that capex is at a much higher level than in the pre-Covid period. Even for next financial year, it is budgeted at 3.1 per cent of GDP. Ms Sitharaman had announced in the 2021-22 Budget that the government intended to attain a fiscal deficit below 4.5 per cent of GDP by 2025-26. Since the government has projected a fiscal deficit of 4.4 per cent for next financial year, it must be commended for that commitment. The fiscal deficit in 2020-21 had expanded to 9.2 per cent of GDP because of the pandemic-related disruption.

 

Although the government has done well in recent years, sustained efforts will be required in this area for a long period. In this regard, the finance minister had announced in the July 2024 Budget that from 2026-27 onwards, the government would keep the fiscal deficit every year at a level that central-government debt as a percentage of GDP remained on a declining path.  The Statements of Fiscal Policy, presented along with the Budget for 2025-26, has details.  According to the statement, the government will aim to attain a debt-to-GDP ratio of 50 per cent, with a band of 1 percentage point on either side, by March 2031. The idea is to avoid being constrained by a specific fiscal-deficit target each year to improve operational flexibility. The projections in the statement show that with 10 per cent nominal GDP growth and mild fiscal consolidation, the debt-to-GDP ratio will decline from 57.1 per cent in 2024-25 to 52 per cent by 2030-31. If the economy grows at 11 per cent nominally and the government adopts a high degree of consolidation, the debt stock will decline to 47.5 per cent of GDP during the same period. Assuming the government achieves the target of 50 per cent by 2031, it would still be on the higher side.

 

It is worth noting that the FRBM Act was amended in 2018 to adopt both fiscal-deficit and debt targets. The target for central-government debt was set at 40 per cent of GDP to be achieved by 2024-25, while the fiscal deficit was to be reduced to 3 per cent of GDP by 2020-21. Based on the recommendation of the FRBM review penal, the target for general government debt was set at 60 per cent of GDP. State-government debt is at about 28 per cent of GDP. Assuming some consolidation in the coming years, general government debt at the end of 2030-31 would still be 70-75 per cent of GDP, which will be on the higher side and remain a source of vulnerability in the given uncertain economic environment. High levels of debt will also continue to pre-empt resources and affect development expenditure. In the coming year, for example, the interest-payment burden of the Union government will be worth over 3.5 per cent of GDP. Although public debt has gone up across the world after the pandemic, it is in India’s interests to reduce it to a more manageable level.