External exposure

Foreign flows will demand strong fiscal management

The White Paper, recently presented by the Union government, emphasised how economic conditions had improved over the past 10 years under the National Democratic Alliance (NDA) government, compared to the two terms of the United Progressive Alliance (UPA) regime (2004-14). As this newspaper has argued in this context, there is little debate that conditions have indeed improved significantly over the past 10 years, but public debt and the general government deficit remain elevated. In fact, the headline fiscal deficit, expressed as a percentage of gross domestic product (GDP), for the Union government in 2023-24, according to the Revised Estimate, was at 5.8 per cent, compared to 4.5 per cent in 2013-14. However, this is largely because of the Covid-19-related disruption. Although the UPA government also dealt with the implications of the 2008 global financial crisis, which led to a significant expansion in the fiscal deficit, the economic impact of the Covid-19 pandemic was much more severe.

Besides, there are at least two qualitative distinctions in the way government finances are managed. First, the quality of reporting has improved, particularly after the pandemic, and the Union Budget is reflecting the actual expenditure. Until a few years ago, the government used off-Budget borrowing to fund expenditures. Second, the quality of expenditure itself has improved considerably. The Union government’s capital expenditure, for instance, has been pegged at 3.4 per cent of GDP in 2024-25. This will not only help the economy, in general, but also give flexibility to the government in terms of containing expenditure over time. As private investment picks up pace, the government can reduce capital expenditure and focus on consolidating its finances. Capital expenditure as part of total expenditure (net of interest payments) was 28 per cent in 2023-24, compared with 16 per cent in 2013-14.

Meanwhile, the NDA government’s revenue expenditure has grown at a slow pace compared to that of the UPA government. This is partly because of effective management and better targeting of subsidies. As the White Paper underscored, revenue expenditure grew by a compound annual growth rate of 9.9 per cent during the NDA’s two tenures, against 14.2 per cent in the previous 10 years. At a broader level, it is also worth noting that deft management on the external front by the Reserve Bank of India (RBI) increased the policy space for the government. However, despite all the positives, the need for fiscal consolidation cannot be overstated. For instance, the Government of India bonds will be added to the emerging market bond index of JP Morgan. Given that assets worth about $230 billion follow the index, about $23 billion is expected to come to India. Some other global indices are also reportedly considering the inclusion of Indian bonds.

The increased flow of foreign money will naturally reduce the pressure on domestic savings to finance the fiscal deficit. While this would lead to a lower cost of money domestically, it would increase the need for greater fiscal discipline and a lower deficit. As RBI Governor Shaktikanta Das rightly noted last year in this context, index inclusion is a double-edged sword. Foreign ownership of government bonds will increase over time, which would demand better and predictable fiscal management. Shifts in index weighting can lead to large outflows, which will also demand agile forex management by the RBI to avoid excess currency volatility. Higher foreign flows in the debt market will be an addition to the list of reasons why India needs strong fiscal management.