Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment; Government Budgeting.

Key Phrases: Fiscal Consolidation, Fiscal Deficit, Union Budget, debt liability, monetising deficit, ad hoc treasury bills, FRBM Act, 2003, Crowding out.

Why in News?

• The Union Budget for 2022-23 will be announced next week. Apart from the possible sectoral allocations and tax concessions expected, a key point that is already being discussed and will continue to be discussed fervently over the next few days will be the estimated fiscal deficit.

Key Points:

• Fiscal deficit is the excess of total disbursements from the consolidated fund of India, excluding repayment of debt, over total receipts into the fund (excluding debt receipts) during a financial year.
  • Simply put, it is the amount the government spent beyond its income and is measured as a percentage of the GDP.
  • FISCAL DEFICIT = TOTAL EXPENDITURE – REVENUE RECEIPTS – CAPITAL RECEIPTS excluding BORROWINGS
• Fiscal consolidation refers to the ways and means of narrowing the fiscal deficit.

Need:

• A government typically borrows to bridge the deficit.
  • It will then have to allocate a part of its earnings to service the debt. The interest burden will increase as the debt increases.
  • In the Budget for FY22, of the total government expenditure of over ₹34.83 lakh crore, more than 8.09 lakh crore (around 20 per cent) went towards interest payment.
• Debt is one liability that is difficult to defer and, at the end of day, the government struggles to find more resources not just for capital expenditure but also revenue expenditure.
• In the long run, uncontrolled fiscal deficit will hurt economic growth.

Steps Taken:

• The seeds for fiscal consolidation were sown in 1994 by the then Finance Minister Manmohan Singh.
  • In his budget speech for FY95, he highlighted the need for fiscal discipline and pronounced a policy to end monetising the deficit.
    • Monetisation of deficit refers to purchase of government bonds by the RBI to help finance the Centre's spending needs.
• Till then the government was financing its deficit by creating money, through unlimited recourse to the Reserve Bank, by issuing ad hoc treasury bills.
• This weakened the Reserve Bank’s ability to direct effective monetary policy.
• FM announced phasing out ad hoc treasury bills, after which the government would fund its deficit through market borrowings.
• As open market borrowings piled up to fund the deficit, Finance Minister Yashwant Sinha in his budget speech for FY01 called for a strong institutional framework to ensure fiscal responsibility.
• This resulted in the enactment of the ‘Fiscal Responsibility and Budget Management (FRBM) Act, 2003’, which mandated limiting the fiscal deficit to 3 per cent of GDP.

India’s Performance:

• When FRBM was enacted, the idea was to limit the fiscal deficit under 3 per cent of GDP by the end of FY08.
  • But that never happened. The fiscal deficit declined from 5.9 per cent in FY12 to 3.4 per cent in FY19.
  • In FY20 it went up to 3.8 per cent.
• The following year, it was proposed at 3.5 per cent, but the pandemic struck and it surged to 9.5 per cent.
• Now, for the current year, it is estimated at 6.8 per cent and the government will seemingly work towards 4.5 per cent by FY26.
• To ensure it was within the law, the government periodically amended the FRBM Act to reset the fiscal deficit target.

A fiscal deficit of 3 per cent now appears to be a distant possibility.

Fiscal consolidation and Growth:

• Many economists have said that speedier economic growth depends on limiting the fiscal deficit.
  • Their reasoning is that high fiscal deficit will increase borrowings and the interest burden would curtail the government’s ability to spend productively.
  • Also, 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 fiscal compression mechanism, rather it is an expenditure switching mechanism.
  • The original FRBM Act of 2003, they say, pushed for shifting the expenditure from revenue to capital, which will lay the foundation for higher growth.
  • They argue that the FRBM Amendment Act of 2018 completely dilutes the original Act to become contractionary.

Way Forward:

• The Fifteenth Finance Commission had suggested a fiscal consolidation path where the Centre’s fiscal deficit was benchmarked at 5.5% of GDP for 2022-23. In their pessimistic scenario, it was kept at 6% of GDP.
• Economist like C Rangarajan suggests that it may be prudent to limit the reduction in fiscal deficit-GDP ratio to about 1% point of GDP in 2022-23. This would imply a fiscal deficit in the range of 5.5%-6% of GDP.
  • From here on, a stepwise reduction of 0.5% points per year would enable a level of about 4% of GDP by 2025-26.
• By this time, as suggested by the Fifteenth Finance Commission, a high-powered inter-governmental group should be constituted to re-examine the sustainability parameters of debt and fiscal deficit of the central and State governments in the light of new empirical realities, particularly taking into account the likely level of interest rate on government debt.

Conclusion:

• In the upcoming Budget, Finance Minister has a challenging task ahead. With Omicron raging and America raring to go in the form of the Federal Reserve's aggressive monetary policy tightening, the budget will need to strike a balance between boosting rural demand and investing in infrastructure in the budget, while continuing on the path of modest fiscal consolidation.

Source: The Hindu BL

Mains Question:

Q. While supporting growth is critical, signalling a return to fiscal consolidation is also important. In this light comment on the need for fiscal consolidation and suggest ways to achieve it.