Flexible fiscal targets

India needs a sustainable and clear framework

Financial markets and economists have welcomed the sustained commitment of the Union government to fiscal consolidation. As Union Finance Minister Nirmala Sitharaman announced in the annual Budget presented in July, the government will aim to contain the fiscal deficit at 4.9 per cent of gross domestic product (GDP) in the current year, compared to the estimate of 5.1 per cent announced in the Interim Budget. The government is on course to restrict the fiscal deficit below 4.5 per cent of GDP in 2025-26, a target that seemed reasonably difficult when it was first announced in 2021. Given the commendable track record of the government in recent years, it was expected to give the road map beyond 2025-26.

Although the government has broadly outlined the approach to be adopted after 2025-26, it would do well to provide more clarity. This will help improve confidence of investors, particularly those with a longer-term view. Ms Sitharaman in her Budget speech noted: “From 2026-27 onwards, our endeavour will be to keep the fiscal deficit each year such that the central government debt will be on a declining path as percentage of GDP.” Post-Budget media interactions of top finance ministry officials suggested that the fiscal deficit, which can be supported while keeping the debt on a declining path, could be more than 3 per cent of GDP, as enshrined in the Fiscal Responsibility and Budget Management (FRBM) Act. It has also been suggested that instead of an annual fixed fiscal deficit target, the government can target a range.

In this context, there are three broad issues that the government would do well to address. First, the government will need to communicate the level of debt reduction it intends to attain over the next, say, five years. The central government debt in the current year is projected to be at 56.8 per cent of GDP, compared to 58.1 per cent in 2023-24. This reduction pace will take a long time to reach the 40 per cent mark recommended in the FRBM framework. A clear medium-term debt target will also help determine the level of fiscal deficit the government can run over a period of time. Second, the issue with having a range for the fiscal deficit target is that the upper end, or a level near the upper end, could become the de facto target. In this regard, it would also be important to determine the width of the range. A wide range will naturally raise questions. There are always pressing demands on the Budget and any democratically elected government would want to address the needs of citizens to the extent possible. It is important to have hard Budget constraints to preserve macroeconomic stability, particularly when debt and Budget deficits are elevated. Therefore, it would be advisable not to set a range for fiscal deficit targets.

Third, medium-term targets should also be decided based on the economy’s financing capabilities. If the public-sector borrowing requirements remain high for an extended period, it will tend to crowd out private investment. The latest numbers showed that household financial savings declined to a multi-decade low of 5.3 per cent of GDP. Therefore, the overall fiscal policy management should be consistent with the need to substantially reduce public debt and the economy’s ability to finance the Budget deficit without compromising long-term growth prospects.