Fiscal correction

Govt should not delay the consolidation process

The Union government is targeting to contain the fiscal deficit at 6.8 per cent of gross domestic product (GDP) this fiscal year, which will be a steep reduction from last fiscal year’s 9.3 per cent. While tax collection in the current year has surprised on the upside, it is being suggested that the government may not be able to attain the target largely because of higher than expected expenditure under different heads and lower disinvestment receipts. Further, as this newspaper reported on Monday, the government is considering not to significantly reduce the fiscal deficit in 2022-23, and keep the target at 6.5-6.8 per cent of GDP. The government would be well advised to avoid this position and continue the consolidation process because of a variety of reasons. It should also aim to attain the current year’s target.

It is plausible that the government would want to support economic recovery with higher expenditure because both consumption and investment demand remain weak. However, it is important to strike a balance without ignoring medium-term policy objectives. The government intends to bring down the fiscal deficit to below 4.5 per cent of GDP by 2025-26, which would still be high but become more difficult to attain if the consolidation process is delayed. GDP growth is likely to be higher in the next fiscal year as well, and that will be an opportunity to consolidate government finances. Since GDP growth beyond 2022-23 is likely to be lower as the base effect wanes, consolidating government finances could become increasingly difficult.
 

A sustained higher general government deficit would also make financing more difficult. Financing large general government deficits has been relatively easy over the last and current fiscal years, largely because of the support of the Reserve Bank of India (RBI). The central bank will not be in a position to extend such support for long. In case it does, it will have consequences for the RBI’s other policy objectives such as price and financial stability. A sustained higher fiscal deficit would also limit the government’s ability to deal with potential shocks. One of the reasons why government intervention remained limited in India after the outbreak of the pandemic, compared to some other countries, was the existing higher level of the general government deficit. Further, a persistently higher fiscal deficit and potentially higher interest rates would limit the possibility of private investment revival. 

Besides, postponing fiscal consolidation will affect the government’s credibility and dent investor confidence. Since the government now intends to finance part of its deficit by tapping foreign savings, fiscal credibility becomes even more important. To be fair, the economic outlook remains fairly uncertain because of the nature of the pandemic, and the economy would need support. In this context, adjustments in fiscal position can always be made during the year if the need arises. However, starting the year with a higher fiscal deficit target would not help and, in fact, increase policy complications over the medium term. As things stand now, the Union government should aim to bring down the fiscal deficit to at least 6 per cent of GDP in the next fiscal year. This would not only demonstrate the government’s commitment to fiscal consolidation but also provide significant support to the economy along with the deficit run by states.