24 April 2024 – The Indian Express

Fiscal Discipline in India

• According to economic theory, governments need to spend more money when individuals and businesses are hesitant to spend. The government need to reduce its spending once the latter is at ease. By using a counter-cyclical fiscal approach, growth is more sustained and smoothed out.
• While governments, particularly those that are democratically elected, find it easy to complete the first task, they are typically unwilling to take a backseat once the economy starts to recover. By implementing sensible fiscal measures, the Indian government appears to be defying this trend with its Interim Budget 2024.

What is the fiscal policy’s cyclicality?

• The term “cyclicality of the fiscal policy” describes how the direction of taxation and spending by the government can fluctuate depending on the state of the economy.
• These deal with policymakers’ decisions that are influenced by changes in the rate of economic growth. Fiscal policies that are cyclical can be classified as either pro- or counter-cyclical.

Fiscal Policy that Is Countercyclical:

• The term “counter-cyclical fiscal policy” describes government actions that deviate from the course of the business or economic cycle.
• Therefore, in order to generate demand that can fuel an economic boom during a recession or downturn, the government raises spending and lowers taxes.

During a Downturn:

• The government adopts an expansionary fiscal policy, which involves raising expenditures while lowering taxes. This boosts the economy’s potential for spending and lessens the impact of the recession.

In a Booming Economy:

• The government adopts a contractionary fiscal policy, meaning that taxes are raised and government spending is cut. This serves to temper the boom by lowering the economy’s potential for consumption.

Fiscal Policy That Is Procyclical:

• Unlike its countercyclical counterpart, procyclical fiscal policy reinforces the current economic trends.

During a Downturn:

• Taxes rise and government spending declines. This further lowers aggregate demand, which exacerbates the recession, raises unemployment, and slows down economic growth.
• This strategy may be interpreted as cutting back during already difficult circumstances, which would make it more difficult for people and companies to recover.

In a Booming Economy:

• Spending by the government rises while revenues fall. This feeds the boom and raises the risk of inflation, asset bubbles, and overheating.
• Enjoying the extra spending during prosperous times may seem pleasant, but it can also lead to weaknesses and exacerbate the inevitable slump.

Which fiscal priorities are counter-cyclical for the government in 2024?

Targets for Fiscal Discipline:

• Macroeconomic stability takes precedence above political posturing for the government, which has set a fiscal deficit target of 5.1% for FY 2024–2025 and pledged to further lower it by FY 2025–2026. Even the predicted fiscal deficit for FY24 is less than the 5.9% budgeted amount, coming in at 5.8% of GDP.
• Despite a substantially lower nominal GDP growth of 8.7% in FY24 compared to a forecasted growth of 10.5%, this was nevertheless accomplished.
• With the tax buoyancy of 1.4 predicted for FY24, the tax buoyancy of 1.1 for FY25 appears to be relatively attainable.

Handling Interest Expenses:

• Because of the large increase in the debt-to-GDP ratio during the pandemic, higher interest costs reflecting previous deficits will continue, necessitating budgetary restraint for a number of years.
• In comparison to the expected Rs 15.4 trillion for FY24, the gross market borrowing for FY25 has been planned at Rs 14.1 trillion.
• This should eventually assist in bringing down the cost of borrowing for corporations generally, which will benefit private investment by bringing down the yields on government bonds.

Spending Quality:

• Enhancing the quality of expenditure is essential to lowering the high debt-to-GDP ratio, which restricts the state’s capacity to foster growth. The goal should be to reduce debt gradually so as not to impair GDP growth.

Evaluating Financial Restraint:

• In order to balance the need for growth and debt reduction, the government is progressively tightening fiscal measures as confidence in the economic recovery grows, going from 0.5% in FY23 to 0.7% in FY25.

Promoting Capital Investment:

• The fact that capital expenditure (capex) increased by 11% over the previous year while overall spending decreased by 6% suggests that medium-term growth drivers, such as interest-free loans for research, are being prioritized.
• The push for capital expenditures (capex) has maintained in the interim budget, which is necessary given the private sector’s recent investment slowdown.
• In FY25, the national government plans to increase its capital expenditure to Rs 11.1 lakh crore. Due to the significant growth multiplier that capital expenditures have, the government has directed its attention towards them in recent years.

Emphasis on Infrastructure:

• With higher budgetary allotments to industries like energy, transportation, and urban development, India’s fiscal strategy has recently been characterized by a strategic concentration on infrastructure development.
• The capital expenditure to GDP ratio was less than 2% in the years prior to the pandemic, but it has been sustained at a high of 3.4% in FY25 (the same as FY24). About 47% of the whole capital expenditure anticipated for FY25 will go toward roads and railroads.

Justifying Subsidies:

• Subsidies have been rationalized with a focus on guaranteeing more focused resource allocation, especially in areas like fuel and food subsidies.
• From an expected Rs 4.4 trillion for FY24, the overall subsidy outlay has been reduced to Rs 4.1 trillion for FY25. As a result, the subsidy-to-GDP ratio drops to 1.3 from 1.5 in FY24 and 3.8 in FY21, the year of the epidemic.
• Fertilizer subsidies have decreased the most, accounting for the majority of the overall subsidy burden decrease; food and petroleum subsidies have decreased somewhat in comparison to FY24.

Increasing Demand in Rural Areas:

• The Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) has received an allocation of Rs 86,000 crore for rural development, which is more than the Rs 60,000 crore anticipated for FY24. This sum is the same as the revised estimate for FY24.
• Under the PM Awas Yojana (Grameen), an additional 2 crore dwellings would be constructed in the following five years, providing a further boost to rural housing. The housing industry has a large multiplier impact, thus this is a positive move for rural development.

What Difficulties Exist in Upholding Countercyclical Fiscal Policy?

Problems with Sustainable Debt:

• The Economic Survey 2020–21 is correct when it says that GDP growth, not other factors, will determine whether or not India’s debt can be sustained.
• It recommended for a Keynesian countercyclical policy response, which has been largely absent in the Indian setting for a long time, and called for breaking the intellectual anchoring that has created an asymmetric bias against fiscal policy.

An unbalanced approach to pro- and counter-cyclical policy:

• A comparison of India’s GDP growth rate and government final consumption expenditure (GFCE) growth rate over the past five years does show some procyclicality, both short- and long-term.
• The issue, however, is that fiscal actions in India during prosperous times are never completely offset during lean times, which leads to an inaccurate deficit bias that jeopardizes the sustainability of debt. From the perspective of maintaining macroeconomic stability, this could be detrimental.

Financial Difficulties Indian States Face:

• Indian States continue to have financial difficulties despite the reduction in the fiscal deficit, particularly in managing their revenue shortfalls, which have not decreased in accordance with the decline in the fiscal deficit.

Challenges Relating to Revenue:

• the Covid-19 pandemic’s effects on economic activity and revenue collection.
• The unpredictability and fluctuations in GST earnings and remuneration.
• the reliance on Union tax devolution and formula-based allocation.
• the loss of fiscal independence brought about by different taxes being combined under the GST.
• The restricted potential for generating non-tax income through fees, charges for users, etc.
• the administrative and compliance problems associated with collecting personal taxes, such as stamp duty and property tax.

Declining Demand for Consumption:

• The GDP of India, which is primarily derived from private consumption, has been declining.
• Urban consumption has decreased due to slower household income growth, but rural consumption has suffered greatly due to three of the last five years’ worth of drought or near-drought conditions and the collapse of food prices.

Issues with Deficit Financing:

• While market borrowings and small-savings programs are the two main sources of deficit financing, they both provide potential risks in an expanding economy. An unaltered fiscal deficit is less worrisome.

Unresolved Cash Balance Issues:

• Increased contributions to small-savings plans may result in a larger cash position than expected, which might put the financial sector under stress and reduce fiscal advantages.
• Recent observations of higher-than-normal government cash stockpiles have the potential to have unforeseen effects that worsen liquidity constraints and reduce the efficacy of monetary policy.

What Path Should We Take Next?

Sensible Position:

• Attain Fiscal Consolidation: In order to get a total debt-to-GDP ratio of 60% for the general government, the NK Singh Committee on FRBM had proposed a debt-to-GDP ratio of 40% for the federal government and 20% for the states.
• State-Level budgetary Reforms: By providing awards or incentives to states that uphold budgetary restraint, the federal government can encourage the adoption of responsible fiscal policies by the states and deter excessive borrowing.

Boost Revenue Further:

• Boost Tax Administration and Compliance: To raise more money for the government, boost tax administration and compliance. By using technology to cross-match income tax returns with GST returns, tax evasion can be reduced and tax collection efficiency increased.
• Streamlining the Administrative Process: Increase revenue by adopting new taxes and implementing them more effectively.
• Disinvestment and Effective Asset Management: To maximize public resources and lessen the need for excessive borrowing, pursue disinvestment and strategic asset management.

Realign Infrastructure and Capacity Building Spending:

• Infrastructure Investments: To increase economic productivity and promote sustainable growth, give priority to investments in physical infrastructure, human capital, and green initiatives.
• Privatization of Public Sector Undertakings (PSUs) at Loss: As was the case with Air India, the government may consider privatizing PSUs at Loss.
• PPP Model in Social Schemes: For initiatives such as Deen Dayal Upadhyay Grameen Kaushalya Yojna (DDU-GKY), the government may consider implementing a public-private partnership (PPP) model. This could contribute to lowering governmental debt.
• Describe Green Debt Swaps: Under a green debt swap, a debtor country and its creditors bargain to exchange or restructure current debt in a way that supports sustainable and ecologically friendly initiatives.
• It allows low-income nations to reinvest a portion of their debt repayment proceeds on health, education, environmental protection, and climate change initiatives. Debt swaps can help the world’s low-income nations avoid default if creditors agree.

Employ Institutional Frameworks:

• Leveraging the Public Financial Management System (PFMS): Making the most of the PFMS is essential to managing the fiscal deficit effectively since it increases accountability and transparency in public spending.
• Creation of the Public Debt Management Agency (PDMA): By centralizing knowledge and duties associated with managing public debt, the PDMA will guarantee a targeted and specialized approach.
• This may result in more strategic planning and decision-making that is more successful in addressing the intricate issues of the nation’s public debt.

Modifying Aspects of Budgeting:

• Assumptions in the budget that are seen as credible include nominal GDP growth and tax-to-GDP ratios. The budget also includes changes in personal and corporate taxes that reflect the post-Covid economic bounce and are crucial for achieving the USD 7 trillion target.
• Budget Numbers Transparency: Reducing extra-budgetary spending should be a priority in order to improve budget transparency. This will bring the primary deficit in FY25 closer to pre-Covid levels and maybe even lower in FY26.
• Medium-Term Fiscal Management: To give the financial markets and private sector stability, the government’s commitment to fiscal consolidation should be in line with this strategy.
• A positive trend towards medium-term fiscal management is evident in the government’s commitment to a counter-cyclical fiscal approach, emphasis on macroeconomic stability, and adherence to a lower fiscal deficit target for FY2024–25 than projected by economists. The budget’s soundness is further improved by the reliable assumptions that underpin it, such as the improvements in tax-to-GDP ratios and realistic GDP growth estimates. To prevent unforeseen effects on liquidity and the efficacy of monetary policy, the possible effects of the government’s financing decisions—particularly with regard to handling larger cash balances—should be carefully considered.