Need for fiscal consolidation – The Hindu BusinessLine

What is the budget deficit?

Fiscal deficit is the excess of total disbursements from the consolidated fund of India, excluding debt repayment, over total fund receipts (excluding debt receipts) during a financial exercise. Simply put, it is the amount the government has spent in addition to its revenue and it is measured as a percentage of GDP.

Why is fiscal consolidation important for an emerging economy?

Fiscal consolidation refers to ways and means to reduce the budget deficit. A government generally borrows to cover the deficit. It will then have to allocate part of its profits to servicing the debt. Interest expense will increase as debt increases. In the FY22 budget, of the total government expenditure of over ₹34.83 lakh crore, over ₹8.09 lakh crore (about 20%) was spent on interest payments. Debt is a difficult liability to carry over and ultimately the government struggles to find more resources not only for capital spending but also for revenue spending. In the long run, an uncontrolled budget deficit will hurt economic growth.

Is fiscal consolidation legally mandatory in India?

The seeds of fiscal consolidation were sown in 1994 by then finance minister Manmohan Singh. In his fiscal year 1995 budget speech, he emphasized the need for fiscal discipline and pronounced a policy aimed at ending the monetization of the deficit. Until then, the government financed its deficit by creating money, by unlimited recourse to the Reserve Bank, by issuing ad hoc Treasury bonds. This weakened the ability of the Reserve Bank to conduct effective monetary policy. Singh announced the phasing out of ad hoc treasury bills, after which the government would finance its deficit by borrowing from the market.

As open market borrowing piled up to fund the deficit, Yashwant Sinha in his fiscal 2001 budget speech called for a strong institutional framework to ensure fiscal accountability. This culminated in the enactment of the “Fiscal Responsibility and Fiscal Management (FRBM) Act 2003”, which required that the budget deficit be limited to 3% of GDP.

How has India fared on this front?

When the FRBM was enacted, the idea was to limit the budget deficit to less than 3% of GDP by the end of FY08. But that never happened. The budget deficit fell from 5.9% in FY12 to 3.4% in FY19. In FY2020, it fell to 3.8%. The following year it was offered at 3.5%, but the pandemic hit and it jumped to 9.5%. Now, for the current year, it is estimated at 6.8% and the government is apparently expected to work at 4.5% by FY26. A budget deficit of 3 percent now seems like a remote possibility. To ensure that it complied with the law, the government periodically amended the FRBM law to reset the budget deficit target.

Is there a trade-off between fiscal consolidation and growth?

It’s debatable. Many economists have said that faster economic growth depends on limiting the budget deficit. Their reasoning is that a high budget deficit will increase borrowing and the interest burden would reduce the government’s ability to spend productively. In addition, increased government borrowing will crowd out the private sector in the debt market, leading to higher interest rates, which will hurt growth. Other economists have argued that fiscal consolidation is not a mechanism for budget compression, but rather a mechanism for redirecting spending. The original FRBM Act of 2003, they say, pushed to shift spending from revenue to capital, which will lay the foundation for higher growth. They argue that the 2018 FRBM Amendment Act completely waters down the original law to become restrictive.

Published on

January 25, 2022

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