In a Pre-Election Budget, Stability -Not Political Gestures

03-02-2024

01:05 AM

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In a Pre-Election Budget, Stability -Not Political Gestures Blog Image

Why in News?

  • Economic theory advocates for counter-cyclical fiscal strategies, urging governments to boost spending during economic downturns and reduce it during recoveries.
  • Considering the interim budget, it is important to look into India's recent fiscal policies, highlighting the government's commitment to macroeconomic stability and its implications for the country's economic growth.

Challenges Faced by Indian Economy After the Covid-19 Pandemic

  • Heightened Debt-to-GDP Ratio
    • The fiscal landscape was significantly altered by absorbing economic losses during pandemic-driven lockdowns, resulting in a nearly 10%-point surge in the debt-to-GDP ratio.
    • Recognising the implications of this heightened ratio, the government acknowledged the imperative for sustained fiscal discipline to revert to pre-pandemic levels.
  • Prolonged Impact on Interest Costs
    • Understanding that interest costs are reflective of past deficits, the fiscal scars from pandemic-driven spending are expected to persist.
    • The government acknowledges that these scars will continue to manifest in higher interest expenses, underlining the necessity of a prolonged period of fiscal prudence.

Concerns Surrounding Deficit Financing and Liquidity

  • Sources of Deficit Financing
    • The government's deficit financing primarily relies on two major sources: market borrowings through bonds and inflows to small-savings schemes.
    • Over the last decade, there has been a noteworthy rise in inflows into small-savings schemes, accounting for more than 2% of GDP.
  • Unchanged Fiscal Deficit and Inflows
    • Despite an unchanged fiscal deficit in absolute terms, the government has witnessed a surge in inflows to small-savings schemes, surpassing initial expectations.
    • In FY24, inflows were nearly Rs 1.5 trillion ahead of expectations, yet the government, for FY25, assumes a decline in these flows.
  • Potential for Higher Cash Balances
    • The conservative assumptions regarding inflows might result in the government ending the fiscal year with a cash balance significantly higher than normal.
    • An excess of Rs 3 to 4 trillion in cash balances, as observed recently, raises concerns about unintended consequences on liquidity in the banking system.
  • Unintended Impact on Monetary Policy and Borrowing Rates
    • Higher government cash balances can lead to unintended liquidity stresses in the banking system, impacting overnight borrowing rates.
    • This situation, where cash balances exceed normal levels, can potentially drive borrowing rates above the intended policy stance, offsetting some gains from fiscal discipline.

The Government’s Approach Highlighted in Interim Budget to Deal with Challenges Faced by Pandemic and Deficit Financing

  • Defying Expectations
    • The government's fiscal approach defies initial expectations, as the fiscal deficit target of 5.1% of GDP for FY2024-25 is notably lower than even conservative economist projections ranging from 5.2% to 5.5%.
    • This unexpected restraint reflects a conscious effort to prioritize long-term economic health over short-term political gains.
    • Long-Term Commitment
    • The Finance Minister's commitment to lowering the fiscal deficit further, aiming for a target below 4.5% of GDP by FY2025-26, signals a sustained dedication to fiscal responsibility.
    • This long-term perspective is crucial for unwinding the fiscal expansion prompted by the pandemic and reinstating pre-Covid levels of economic stability.
  • Ambitious Reduction in Primary Deficit Ratio
    • Notably, the targeted primary deficit ratio for FY2024-25 is set at 1.5%, representing a deliberate reduction compared to the primary deficit observed in FY20.
    • The government's ambitious target for FY2025-26, aiming for a primary deficit of 0.8% of GDP, implies a comprehensive unwinding of fiscal measures initiated during the pandemic.
  • Interest Costs and Fiscal Scars
    • The acknowledgment that interest costs reflect past deficits underscores the government's awareness of the long-lasting impact of fiscal decisions.
    • The nearly 10%-point increase in the debt-to-GDP ratio during the pandemic necessitates a prolonged period of fiscal discipline to mitigate the economic scars left by absorbing significant losses.
  • Steps to Enhance the Quality of Spending and Debt-to-GDP Ratio
    • Enhancing the quality of spending is crucial to reduce the elevated debt-to-GDP ratio, allowing the state more flexibility to support growth in the event of unforeseen economic shocks.
    • The government aims to achieve this through a focus on capital expenditure, with a notable 11% year-on-year growth, signalling a commitment to long-term economic drivers.
  • Credible Assumptions and Transparency
    • Credible assumptions underpin the budget, with a reasonable 10.5% nominal GDP growth assumption and consistent tax-to-GDP trends.
    • Improved transparency in budget numbers, including a reduction in extra-budgetary spending, contributes to a more reliable fiscal framework. 

Way Forward

  • Need for Fiscal Discipline
    • Fiscal discipline is deemed essential for an extended duration to witness a gradual reduction in the debt-to-GDP ratio.
    • The targeted fiscal deficit of 5.1% of GDP for FY2024-25, lower than anticipated, indicates a deliberate effort to curtail government spending and navigate the path towards fiscal sustainability.
    • A high debt-to-GDP ratio limits the government's ability to provide substantial support for economic growth in the event of unforeseen shocks.
    • The need for sustained fiscal discipline is thus not only a corrective measure for past excesses but also a proactive strategy to ensure resilience against potential economic vulnerabilities.
  • Need for Sensible Cash Management
    • Managing the surge in inflows and consequent cash balances requires a nuanced approach to prevent unintended consequences on monetary policy.
    • Sensible cash management becomes essential to strike a balance between maintaining economic stability and adhering to fiscal discipline.

 Conclusion

  • India's fiscal strategy reflects a delicate balancing act between stimulating economic growth, reducing debt, and maintaining macroeconomic stability.
  • While the government's commitment to fiscal discipline is commendable, careful consideration of deficit financing sources and managing liquidity concerns remains crucial for sustaining the positive trajectory of the economy.

Q1) What is the fiscal deficit?

Fiscal deficit is the difference between a government's total revenue and its total expenditure, excluding money from borrowings. It reflects the extent to which a government needs to borrow to meet its spending requirements. A higher fiscal deficit indicates that the government is spending more than it is earning.

Q2) Why is the fiscal deficit important for an economy?

Fiscal deficit is crucial as it reflects the government's fiscal health and its ability to manage finances. A sustainable fiscal deficit is essential for economic stability. Excessive deficits may lead to increased borrowing, raising concerns about inflation, higher interest rates, and potential negative impacts on the overall economy. Monitoring and controlling fiscal deficits are key aspects of sound fiscal policy to ensure long-term economic sustainability.


Source: The Indian Express