Date : 27/07/2023

Relevance – GS Paper 3 – Indian Economy – Fiscal policy and Fiscal Consolidation

Keywords – Public debt, Fiscal deficit, GDP, Covid-19 pandemic

Context -

India's fiscal deficit and public debt have been long standing concerns, even before the COVID-19 pandemic. The country had one of the highest debt levels among developing economies and emerging markets. The pandemic exacerbated the situation, leading to a surge in fiscal deficit and aggregate public debt relative to GDP. Although the economy has shown signs of recovery, projections indicate that the debt levels may not return to pre-pandemic trajectories in the medium term. Moreover, with upcoming state and general elections, there is a possibility of further increase in the debt ratio. To ensure fiscal sustainability, targeted interventions are crucial, though politically challenging during the election period.

India's Fiscal Deficit and Public Debt:

India's fiscal deficit and public debt are closely related, with the former representing the difference between government expenditure and revenue. The fiscal deficit is financed through borrowings, leading to a rise in public debt. Before the pandemic, India's fiscal deficit was already a matter of concern, and the pandemic-induced economic downturn further widened the gap. In 2020-21, the fiscal deficit increased to 13.3% of GDP, and the aggregate public debt reached 89.6%. As the economy recovered, these numbers receded to 8.9% and 85.7%, respectively.

Challenges in Achieving Fiscal Consolidation:

Despite the post-pandemic recovery, returning to pre-pandemic debt levels in the medium term appears unlikely. The forthcoming state and general elections may further complicate the situation, as governments tend to spend more during electoral cycles, potentially increasing the debt burden. This raises questions about the sustainability of the current debt trajectory and the need for targeted interventions.

Financial Repression and Its Impact:

Financial repression, where the government keeps interest rates on its borrowing artificially low, is a common tool used to reduce the cost of debt. The Reserve Bank of India (RBI) mandates the statutory liquidity ratio (SLR) for banks, requiring them to hold 18% of their demand and time liabilities in government securities. The RBI also intervenes in the market through open market operations to keep interest rates repressed during government borrowing. While this may lead to a decline in debt, it creates distortions in the financial market.

Impact of High Deficits and Debt on the Economy:

Carrying high deficits and debt has significant costs for the economy. Firstly, interest payments constitute a substantial portion of GDP and revenue receipts, crowding out crucial expenditures on education, healthcare, and infrastructure. States like Punjab, Kerala, Rajasthan, and West Bengal face concerning debt-to-GSDP ratios, affecting their ability to invest in critical sectors.

Secondly, high levels of debt limit the government's ability to implement counter-cyclical fiscal policies, hindering its response to economic shocks.

Thirdly, India's debt market is mainly captive, with commercial banks and insurance companies participating to meet SLR requirements. The limited resources available for lending to the manufacturing sector drive up borrowing costs for industries. The sovereign rating also affects external commercial borrowing costs, while the burden of deficits and debt ultimately falls on future generations.

Policy Interventions and the Role of the State:

To address the fiscal challenges, policy interventions are essential. The stabilization of Goods and Services Tax (GST) after six years and improved compliance are expected to increase the aggregate tax-GDP ratio. However, the government must also reevaluate its role and avoid competing with the market in areas where the private sector can be more efficient.

At the central level, progress in disinvestment needs acceleration to reduce the government's involvement in non-essential activities. For instance, activities like telecom should be entrusted to the private sector rather than being subsidized by government funds. Similarly, avoiding large-scale giveaways for electoral reasons at the state level can help in maintaining fiscal discipline.

Cash transfers are more efficient than commodity and service subsidies, which lead to resource distortions. Enforcing Fiscal Responsibility and Budget Management rules on states can impose hard budget constraints, and the Union government should lead by example in following these rules.

Conclusion:

India's fiscal deficit and public debt pose significant challenges to the country's economic sustainability. While the pandemic has worsened the situation, the focus must now be on fiscal consolidation and long-term solutions. Targeted interventions, reevaluating the role of the state, and adherence to fiscal discipline can pave the way for a sustainable and resilient economy. By addressing the high deficits and debt burden, India can ensure better economic growth, improved investment in critical sectors, and secure future prospects for its citizens.

Source – The Hindu