Medium-term: revisiting fiscal policy framework
The Economic Survey of FY21 prepared the background for justifying a sharp departure of center’s fiscal deficit in FY21 (RE) and FY22 (BE) from the corresponding FRBM norms (2018) and the medium-term path of the fiscal deficit that was stipulated in the FY21 Budget. This justification was based on a comparison of the nominal growth rate and the effective interest rate on government borrowing. As long as the excess of nominal growth rate over effective interest rate is large, a relatively high primary deficit and fiscal deficit relative to GDP may be justified. The 15th FC had also examined this issue and had recommended a fiscal deficit of 6.5% of GDP for the center for FY22. Their proposed path indicates a gradual reduction in the fiscal deficit to GDP ratio of the central government by an annual margin of 0.5% points thereby reaching the level of 4.5% by FY26. The Commission also recommended that the FRBM norms may be examined afresh by a High-Powered Intergovernmental Group.
In the ‘medium-term fiscal policy cum fiscal policy strategy statement’ appended to the FY22 Budget, an estimation of government debt relative to GDP for the center, which used to be given, has not been provided. According to our estimates, using the budget assumption regarding nominal GDP growth and the fiscal deficit numbers, center’s debt to GDP ratio is projected at 62.2% at the end of FY21 and 61.0% at the end of FY22. Also, the estimated combined debt-GDP ratio by end-FY21 and end-FY22 respectively are at 88.0% and 87.5%. At such high debt-GDP levels, the burden of interest payment relative to GDP and relative to revenue receipts will become inordinately high thereby reducing the scope for primary deficit for any given level of fiscal deficit. In making international comparisons, we may note that for a number of developed countries, the general government debt-GDP ratio is projected to be higher than 100% by the end of 2020 and 2021 but in their case, the nominal interest rates are quite low, sometimes negative, and the revenue receipts to GDP ratios are much higher than that for India.
Achieving a more sustainable fiscal deficit path would require substantial improvement in center’s revenue flows. A major fiscal challenge relates to the performance of center’s gross tax revenues which have contracted in two successive years namely, FY20 and FY21 (RE). A longer-term and critical issue in the management of India’s public finances is the decline in the growth rate of center’s GTR on trend basis since FY08. After rising to about 16.7% in FY07, the trend growth rate of center’s GTR has fallen to 4.8% by FY22 (BE). Unless the growth rate in center’s GTR increases to 10% or above on a sustained basis and revenues from non-tax sources become buoyant, the reliance on larger fiscal deficit may become necessary for some more years.
The budget has indicated that the fiscal consolidation framework would be re-examined with a view to amending the FRBM Act. For this purpose, there is a need to specify a steady state path of fiscal deficit consistent with the relative levels of trend GDP growth rate and trend interest rate. As a second step, around this steady state path, rules for countercyclical departure of fiscal deficit and its extent will have to be specified. It may be noted that in the 2018 amendment to center’s FRBMA, such rules were specified but they proved to be impractical and ineffective. This Act may now be re-amended in the context of India’s contemporary empirical realities in the post-Covid global economy.