Increasing fiscal constraints

One of the criticisms of the Union Budget for 2021-22 has been inadequate spending to overcome the massive economic disruption following Covid-19. The increase in expenditure for the current year is largely because of transparent accounting of subsidies. According to the revised estimates, the fiscal deficit will expand to 9.5 per cent of gross domestic product (GDP) in the current year, and is estimated at 6.8 per cent for FY22. Clearly, these are not small numbers and should be seen in the context of a significant rise in public debt, which is likely to settle at around 90 per cent of GDP in the current fiscal year. It is important to recognise that the deficit will remain at higher levels even in the coming years — the new fiscal glide path is fairly relaxed. According to the Fifteenth Finance Commission’s (FFC’s) projections, general government debt will remain elevated in the foreseeable future and is pegged at 85.7 per cent of GDP in 2025-26.

A higher level of debt will increase macroeconomic risks. To be sure, debt sustainability to a large extent will depend on India’s post-Covid growth trajectory. In this context, the government expects the economy to expand by 14.4 per cent in nominal terms in FY22. Assuming inflation at about 4 per cent, this would result in real GDP growth of a little over 10 per cent. However, going back to the FY20 GDP level after a contraction in the current year would itself show a growth rate of over 8 per cent. It is likely that, given the potential risks, the government has taken a conservative view. However, if the growth rate remains low in the coming years, as some economists are projecting, higher debt could pose significant risks. In fact, it could start undermining growth.

A higher debt stock and increased interest liabilities will lower capital and social sector expenditure, which will directly affect growth potential. For instance, over 52 per cent of the Central government’s tax revenue will go towards interest payments in FY22. A higher level of debt and Budget deficit will also limit the government’s ability to take countercyclical measures in the case of an economic shock. Besides, continued higher government borrowing will affect market interest rates. The Reserve Bank of India could not sell government bonds last week because of the demand for higher yields. Borrowing costs for state governments have started rising materially. Higher market interest rates could affect economic recovery. But the central bank’s sustained liquidity infusion to manage yields could affect inflation outcomes.

Globally, on the back of lower interest rates, advanced economies are adopting a more liberal fiscal approach. India is not in a position to embrace the same path. Inflation, for instance, is still a worry and higher debt can create instability in a developing country fairly quickly. Thus, instead of making higher public debt a permanent constraint for the Indian economy, the government should address its inability to mobilise revenues. India’s tax-GDP ratio has remained largely static for decades. The implementation of goods and services tax has also not worked as desired. As the FFC has highlighted, the gap in India’s tax collection, compared to the potential, is worth over 5 per cent of GDP. The government will need to systematically work on increasing tax revenues by broadening the base. A static tax-GDP ratio, higher public debt, lower economic growth, and rising governance requirements will only increase policy challenges in the coming years.


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