India’s economic landscape is evolving, and with the Budget 2025 on the horizon, the focus on managing the fiscal deficit is more critical than ever. Following a challenging period marked by the Covid-19 pandemic, India’s fiscal deficit ballooned to a staggering 9.2% of its gross domestic product (GDP) in FY 2021. Navigating from this high point to a reduced deficit of 5.6% in the previous fiscal year was a notable achievement for the Centre. Looking ahead, there are ambitious goals to bring it down further to 4.9% this fiscal and approximately 4.5% by the next.
The current economic conditions present a complex backdrop for these targets. While reducing the fiscal deficit is essential to alleviate the government’s debt burden, aggressive measures may not be feasible. India’s debt-to-GDP ratio is projected at 56.9% this fiscal year, while including sub-national debts, it skyrockets to 80%. This figure far exceeds the Fiscal Responsibility and Budget Management target of 60%, with a specific target of 40% for the Centre.
The Covid-19 pandemic dramatically increased public debt, driving it to 61.5% in FY 2021. Although most of this debt is managed internally by households, banks, and financial institutions and is deemed sustainable, it still constrains the government’s fiscal maneuverability. High debt inhibits governmental response to economic shocks, stifles growth-oriented investments, and raises borrowing costs for the private sector.
Importantly, the perception of India’s economy abroad is heavily influenced by its fiscal standing. With increasing geopolitical uncertainties, resetting global supply chains, and rising trade vulnerabilities, maintaining a financial buffer is imperative to weather potential storms. Historically, the Centre successfully trimmed its debt ratio between FY 2004 and FY 2008, capitalizing on a more favorable macroeconomic environment. Nevertheless, the current context paints a different picture where growth has tempered, and calls for increased governmental support are louder than ever.
This year, achieving further fiscal consolidation will be a balancing act. Following the pandemic, the reduction in the fiscal deficit stemmed from a combination of restrained government spending and rising revenue collections. The slowing of expenditure was largely due to increased efficiency and stricter revenue management, alongside a remarkable uptick in dividends from public sector undertakings and the Reserve Bank of India.
As the benefits from improved compliance fade, tax growth has already started to plateau. Though non-tax collections may remain robust, the sustainability of these revenue streams is questionable. Sustaining revenue growth is vital for reducing the fiscal deficit and can be facilitated by broadening the tax base. However, enhancing the economy’s potential for expansion is equally essential for maintaining healthy tax revenues.
Thus, accelerating economic growth becomes a fundamental objective in achieving fiscal consolidation. The post-pandemic landscape highlighted the public sector’s essential role in revitalizing investments and spurring growth. While lower government investment spending may help to minimize the Centre’s budget deficit, it can also curtail economic momentum, significantly when private sector investments are not keeping pace.
Over the last decade, the share of private investment in total fixed investments has dropped from a peak of 41% to 37% for FY 2024. Today’s investments predominantly flow into emerging sectors, often bypassing traditional heavy industries. In light of these trends, the government’s involvement in economic growth is essential, which lowers the feasibility of further expenditure cuts. Reducing government spending may inadvertently stifle growth, particularly as the economy faces reduced growth projections—expected to drop to 6.4% in FY 2025 from 8.2% in FY 2024.
As urban demand falters and inflation coupled with rising interest rates weighs on consumers, maintaining government-funded employment and income-generating schemes has become necessary to sustain immediate demand. A strategic combination of fiscal allocations that promote infrastructure development—such as roads, railways, and housing—while generating employment, aligns with monetary policy goals in a non-inflationary manner.
The objective remains clear: reduce the government’s debt burden. Rapidly decreasing the fiscal deficit can pave the way for lowered debt levels in the short term, but this may come at the cost of growth. Therefore, a prudent approach is warranted—one that gradually and sustainably looks to bring down the debt burden while allowing for adaptability, particularly in times of uncertainty.
Globally, a trend is emerging in refining budget deficit and public debt management rules favoring growth-friendly fiscal strategies. Perhaps it is time for India to rethink its fiscal framework in light of this growth-centric focus. The financial landscape necessitates a recalibration, balancing the urgent need for debt reduction with the essential goal of reviving economic growth—a challenge that demands careful planning and pragmatic execution.
In conclusion, as Budget 2025 approaches, the Indian government faces the dual challenge of consolidating fiscal policy while fostering an environment conducive to growth. The careful management of the fiscal deficit and embracing a holistic approach towards economic revitalization will be fundamental in establishing a resilient future for the nation.
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