Fiscal Future of India : Achievements and Challenges

Introduction

India’s fiscal finances have shown improvement in terms of spending quality, with increased capital spending by the central government on infrastructure projects. Additionally, the fiscal deficit of the states is under control and remains at pre-pandemic levels. However, there are still concerns that need to be addressed. This article examines the current state of India’s fiscal future, discussing both the achievements and challenges that lie ahead.

Achievements in Fiscal Finances

Rise in Capital Spending

The central government has significantly increased capital spending, focusing on the development of roads and railways. This expansion in infrastructure investment has contributed to the better quality of spending.

Controlled State Fiscal Deficit

The states have managed to keep their fiscal deficits in check, maintaining levels similar to those before the pandemic. Despite a sharp decline in revenue, the states have curtailed expenditure, minimizing any fiscal slippages.

Challenges in Fiscal Consolidation

Public Sector Borrowing

India’s public sector borrowing remains in double digits, posing as a challenge to fiscal consolidation. The planned reduction in the fiscal deficit by the central government, from 6.4% of GDP in 2022-23 to the target of 4.5% in 2025-26, is yet to be fully implemented. Historical data suggests that such consolidation efforts become more challenging over time, as difficult decisions need to be made. For example, whether to cut capital expenditure to lower the fiscal deficit.

Rising Spending Commitments

Despite efforts to consolidate, some spending commitments have increased. One such commitment is the extension of the free food scheme. These rising liabilities add to the complexity of achieving fiscal targets.

Analysis of the Current Year

Challenges to Achieving Fiscal Target

Several challenges in the current year may hinder the goal of attaining the fiscal target of 5.9% in 2023-24. These challenges include the high growth in capital expenditure thus far in the year and pre-election spending. However, the unexpectedly high direct tax collections and a reduction in capital expenditure for the remainder of the year could potentially mitigate these challenges. Furthermore, the quality of spending by the states has improved significantly this year.

Disparity in GDP Growth and Fiscal Deficit

Despite robust GDP growth, projected by the Reserve Bank of India at 6.5% for the current year, the central government’s fiscal deficit remains comparatively higher (5.9% target for 2023-24 versus 3.4% in 2018-19, the last ‘normal’ pre-pandemic year). This raises the question of why the fiscal deficit has not proportionately aligned with economic growth.

Addressing the Fiscal Deficit

Focus on Current Expenditure

To address the fiscal deficit, greater emphasis should be placed on curtailing the growth of current expenditure. While capital spending has increased by 1.1% of GDP compared to 2018-19, current expenditure has nearly doubled during the same period. Hence, efforts toward fiscal consolidation should primarily target current expenditures.

Lowering the Fiscal Deficit Target

A reasonable objective would be to bring the fiscal deficit back to the pre-pandemic level of 3.4% of GDP. This requires a consolidation of approximately 2.5 percentage points from the 2023-24 levels.

Pathways for Consolidation without Cutting Capex

Various strategies can be explored to achieve fiscal consolidation without reducing capital expenditure:

1. Raising Gross Taxes: Although tax revenue has grown faster than national income this year, primarily due to falling commodity prices, this boost might not be sustainable. Hence, solely relying on higher taxes is not a viable solution for consolidation.
2. Increasing Net Taxes: The central government’s tax devolution to the states has already declined as a share of GDP in recent years, leaving limited room for further reduction. This restricts the potential increase in net tax revenues.
3. Enhancing Disinvestment Receipts: Disinvestment receipts, which arise when the government sells its assets, have been disappointing in recent years. Exploring strategies to generate higher disinvestment receipts could contribute to fiscal consolidation efforts.
4. Trimming Subsidies: Despite recent forays into direct cash transfers, overall subsidies have increased compared to 2018-19 levels. Measures should be taken to gradually reduce subsidies, including reforming price subsidies and optimizing income support programs.
5. Managing Other Current Expenditures: Central government-sponsored schemes, after experiencing a reduction, have seen an increase in recent years. Although these schemes are being encouraged, it is unlikely that they will be significantly curtailed in the near future.

Importance of Economic Growth

India’s experience with fiscal consolidation during the period of 2001-2007 highlights the significance of high economic growth. Historically, periods of strong GDP growth have facilitated tax revenue growth, while pressures on expenditure have remained manageable. Consequently, achieving sustained high economic growth, coupled with a firm commitment to fiscal consolidation, is crucial for India’s fiscal future.

Conclusion

India’s fiscal outlook shows promising aspects, such as improved spending quality and controlled state fiscal deficits. However, challenges remain, particularly concerning the central government’s fiscal deficit and rising spending commitments. Addressing these challenges requires a focus on curbing current expenditures and exploring various consolidation pathways. Furthermore, sustaining high economic growth, alongside a commitment to fiscal discipline, is essential for India’s fiscal future.