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Stick to Fiscal Deficit as the Norm for Fiscal Prudence

Last updated on September 11th, 2024 Posted on September 11, 2024 by NEXT IAS Current Affairs Team  830

Syllabus: GS3/ Economy

Context

  • In the 2024-25 Union Budget, the Finance Minister stated, “From 2026-27 onwards, we aim to reduce the fiscal deficit each year to ensure Union government debt declines as a percentage of GDP.”
  • The speech also says that the Centre’s fiscal deficit would be reduced to 4.5% of GDP in 2025-26 from its budgeted level of 4.9% in 2024-25.

What is the fiscal deficit?

  • Fiscal Deficit is defined as excess of total budget expenditure (revenue and capital) over total budget receipts (revenue and capital) excluding borrowings during a fiscal year.
  • Fiscal Deficit = Total Expenditure – (Revenue Receipts + Non-Debt Creating Capital Receipts).

National Debt

  • The fiscal deficit is different from the national debt. 
  • The national debt is the total amount of money that the government of a country owes its lenders at a particular point in time. 
  • It is usually the amount of debt that a government has accumulated over many years of running fiscal deficits and borrowing to bridge the deficits. 

Implications of fiscal deficit

  • Inflationary Pressure: When a country’s government runs a persistently high fiscal deficit, this can eventually lead to higher inflation as the government will be forced to use fresh money issued by the central bank to fund its fiscal deficit. 
  • Higher fiscal deficit causes higher debt which eventually leads to the higher ratio of interest payment to revenue receipts. Hence there will be lower shares for financing non-interest expenditures.
  • Crowding Out effect: When the government borrows a large portion of available funds from financial markets to finance its deficit, it crowds out private investment with reduced access to credit for businesses and individuals.
    • This can hinder economic growth and productivity.
  • Reduced Fiscal Space: A high fiscal deficit limits the government’s ability to respond to economic shocks or crises.
    • With limited fiscal space, the government may be unable to implement countercyclical fiscal policies such as increased spending or tax cuts to stimulate economic growth during downturns.
  • Difficulty in borrowing: As a government’s finances worsen, demand for the government’s bonds begins to drop, forcing the government to offer to pay a higher interest rate to lenders. 

Benefits of lower fiscal deficit

  • A consistent reduction in the fiscal deficit will improve credit ratings by international rating agencies. Higher credit ratings make it cheaper for India to borrow in global markets, reducing the cost of external debt.
  • When the fiscal deficit is lower, less money is diverted to debt servicing, leaving more funds for development projects like infrastructure, education, and healthcare.
  • Lower deficits will improve the balance of payments in favor of India, by reducing the reliance on foreign borrowing. It will  help in stabilizing the exchange rate and the overall current account.
  • A lower fiscal deficit signals fiscal discipline and responsible government management of finances. This can enhance investor confidence, leading to increased foreign and domestic investment.

The reforms needed

  • There is a need to follow the recommendations of the NK Singh committee, 2017 which proposed a draft Debt Management and Fiscal Responsibility Bill, 2017.
  • Incentivizing Financial Savings: Promoting higher household financial savings through tax incentives on financial products, improving returns on long-term savings schemes, and enhancing financial literacy.
  • Infrastructure Finance Reforms: Improving mechanisms for financing infrastructure projects by involving the private sector through public-private partnerships (PPP), infrastructure bonds, and development of finance institutions.
NK Singh committee recommendation
– Debt to GDP ratio: The Committee suggested using debt as the primary target for fiscal policy. A debt to GDP ratio of 60% should be targeted with a 40% limit for the center and 20% limit for the states by FY23.
– The fiscal deficit to GDP ratio of 2.5% by FY23.
Fiscal Council: The Committee proposed to create an autonomous Fiscal Council with a Chairperson and two members appointed by the center. The role of the Council would include:
1. Preparing multi-year fiscal forecasts, 
2. Recommending changes to the fiscal strategy, 
3. Improving quality of fiscal data, 
4. Advising the government if conditions exist to deviate from the fiscal target.
– Deviations: The Committee suggested that grounds in which the government can deviate from the targets should be clearly specified, and the government should not be allowed to notify other circumstances.
– Debt trajectory for individual states: The Committee recommended that the Finance Commission should be asked to recommend the debt trajectory for individual states. 
1. This should be based on their track record of fiscal prudence and health. 

Concluding remarks

  • The recent pronouncements talk of the debt-GDP ratio as the policy variable, however they do not specify what that target is for India and what the path would be to reach that target from the current levels of debt-GDP ratio.
  • With the current lower levels of household financial savings, it is better for the central government to stick to 3% of GDP as a limit to fiscal deficit. Any relaxation of this rule will only lead to fiscal imprudence.

Source: TH

 
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