FISCAL CONSOLIDATION IN INDIA
India’s fiscal consolidation process has seen significant progress, particularly following the economic challenges induced by the COVID-19 pandemic. The fiscal deficit in India reached a peak of 9.2% of GDP in FY 2020-21 but has been steadily reduced to an estimated 5.6% in FY 2023-24, with a target of 4.9% in FY 2024-25. This reduction reflects the country’s commitment to fiscal discipline under the framework of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.
What is Fiscal Consolidation?
Fiscal consolidation is the process of managing a country’s finances by improving revenue collection, controlling public spending, and reducing fiscal deficits. It aims to minimize excessive borrowing and debt, stabilize the economy, and promote sustainable economic growth.
Key Features of Fiscal Consolidation:
- Prudent Spending: Focuses on essential areas like infrastructure, education, and healthcare to boost economic growth.
- Revenue Optimization: Aims to improve tax collection, broaden the tax base, and reduce tax evasion.
- Deficit Control: Seeks to limit fiscal deficits to avoid excessive borrowing and its negative impact on the economy.
- Debt Management: Ensures that public debt remains sustainable over the long term to prevent future economic crises.
- Accountability: Ensures transparency through audits and compliance with financial regulations.
Significance of Fiscal Consolidation
Macro-Economic Stability:
- Helps control inflation by reducing government borrowing, which limits the circulation of money.
- Stabilizes currency exchange rates, minimizing exchange rate volatility.
- Promotes consistent economic growth by curbing inflationary pressures and maintaining fiscal discipline.
Reduced Debt Burden:
- Reduces the need for borrowing, preventing the burden of debt from being passed on to future generations.
Investor Confidence:
- Sound fiscal management attracts both domestic and foreign investors, fostering economic growth.
Efficient Resource Utilization:
- Redirects government spending towards essential sectors, minimizing waste and ensuring the efficient use of resources.
Impact of Fiscal Consolidation on Economic Stability and Growth
Inflation Control:
- The FRBM Act aims to reduce the fiscal deficit to 3% of GDP, promoting stability in government borrowing and keeping inflation under control.
Capital Expenditure (Capex):
- India focused on increased investment in infrastructure during the COVID-19 pandemic to support economic recovery, raising capex from 1.6% of GDP in FY 2014-15 to 3.2% in FY 2023-24.
- This increased investment has strengthened economic foundations and mitigated the impact on vulnerable sectors.
Revenue Mobilization:
- The digitization of the tax system has enhanced efficiency, leading to an increase in tax receipts from 10% of GDP in FY 2014-15 to 11.8% in FY 2023-24.
- Higher revenues allow the government to invest more in public services, improving long-term growth prospects.
Long-Term Structural Reforms:
- Programs like the Production Linked Incentive (PLI) scheme have been implemented to boost domestic manufacturing, reducing India’s dependency on imports and improving the trade balance.
Enhanced Export Competitiveness:
- As the fiscal deficit reduced, India became more competitive in the global market, boosting exports and reducing the dependency on imports.
About FRBM Act, 2003
The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was introduced to promote fiscal discipline in India. Its main objective is to reduce the fiscal deficit and control public debt.
Key Features of the FRBM Act:
- Deficit Reduction: The Union Government is required to reduce its fiscal deficit to 3% of GDP, and states are expected to reduce theirs to 3% of GSDP (Gross State Domestic Product).
- Revenue Deficit: The Act originally aimed to eliminate the revenue deficit by 2008, though it was later amended to aim for a 0% effective revenue deficit.
- Escape Clause: The Act allows the government to exceed the fiscal deficit target by 0.5% of GDP during times of national crises or severe economic stress.
- Amendments: In 2012, the Act was amended to remove the requirement for a 0% revenue deficit, and in 2016, the NK Singh Committee recommended focusing on debt reduction rather than strictly adhering to fiscal deficit targets.
Challenges in India’s Fiscal Consolidation
- Compromising Welfare: Critics argue that excessive focus on deficit reduction may limit essential welfare spending, which is vital for long-term economic growth.
- Geopolitical Tensions: Global trade disruptions and rising tariffs, especially from countries like the US, may impact India’s trade balance and economic stability.
- Volatile Capital Flows: Changes in global interest rates or investor sentiment could lead to unpredictable capital flows, creating pressure on India’s fiscal health and currency stability.
- Rising State Deficits: Some Indian states, such as Himachal Pradesh and Andhra Pradesh, have fiscal deficits exceeding the 3% of GSDP target, further complicating the fiscal consolidation process.
- Sustaining Capex: Maintaining the momentum of capital expenditure without triggering further fiscal deficits is challenging due to high borrowing costs and weak tax compliance.
Way Forward
Tax Reforms and Mobilization:
- Enhancing tax collection, particularly from the informal sector, will be essential to meet fiscal targets without overburdening the economy.
- Reducing leakages and improving tax compliance are critical for sustainable revenue generation.
State-Level Reforms:
- States should implement fiscal reforms tailored to their specific challenges, focusing on reducing wasteful expenditures and improving efficiency.
Balancing Investment and Deficit Control:
- While fiscal consolidation is important, India must ensure that it does not hinder long-term investment in critical sectors such as infrastructure, health, and education.
Monetary and Fiscal Coordination:
- Effective coordination between the Reserve Bank of India (RBI) and the government is necessary to manage economic volatility and keep inflation under control.