Recalibrating spend

RBI paper redefines the capex-revenue debate

The government’s commitment to rein in the fiscal deficit and limit borrowing from abroad was re-emphasised in the Interim Budget earlier this month. A gross fiscal deficit of 5.1 per cent of gross domestic product (GDP) has been budgeted for in FY25, reflecting a consolidation of 71 basis points over FY24 (Revised Estimate). The tax-GDP ratio has also increased from 10.1 per cent in FY14 to 11.7 per cent in FY25 (Budget Estimate), along with improvements in tax-revenue buoyancy. At the same time, restrained growth in revenue expenditure, coupled with the impetus provided to capital expenditure, signifies that a greater share of the borrowing is now directed towards financing capex. Notably, the secular decline in the ratio of revenue expenditure to capital outlay indicates the government’s efforts to improve the quality of expenditure, while remaining on the path of fiscal consolidation.

In this context, a recent research article published by the Reserve Bank of India does well to examine the linkages between economic growth and fiscal consolidation in the country. Interestingly, the paper redefines capex and looks at developmental expenditure (DE) instead — it is broader in scope as it includes social and economic expenditure, covering allocations for health, education, skilling, digitisation, and climate-risk mitigation. The purpose is to capture components of revenue expenditure that can actually result in physical and human capital formation, while discarding parts of capital expenditure that are not strongly growth-inducing. As against capex, which is budgeted to account for 3.4 per cent of GDP in FY25, DE is set to be around 4.2 per cent in the same year.

It is commonly believed that lower government spending depresses economic growth in the short run. But fiscal consolidation can boost growth in the long run through lowering of long-term interest rates, which crowds in private investment and, at the same time, creates the fiscal space for more productive expenditure such as public investment in physical and human capital and targeted social spending. To this end, measures suggested by the paper include the reskilling and upskilling of the labour force, investing in digitisation, and attaining energy efficiency. Employing a macroeconometric framework, the paper concludes that a 1 per cent rise in real DE can have a cumulative multiplier impact that produces a 5 per cent rise in GDP over four years. A uniform 5 per cent rise in employment (including training and skilling) in sectors with high labour productivity (such as chemicals, financial services, and transport) for one year can contribute more than 1 percentage point rise in GDP growth over the period 2024-31. Similarly, digitisation and reduced energy intensity can raise growth in the medium term by enhancing labour and capital augmenting technology growth. There are short-term pains (as seen in a sharp rise in the debt-GDP ratio), but the long-run gains more than offset the short-run costs, indicating strong complementarities between judicious fiscal consolidation and growth. Recalibrating government expenditure towards DE can reduce the general government debt-GDP ratio to 73.4 per cent by 2030-31, contrary to the International Monetary Fund’s projection that general government debt would exceed 100 per cent of GDP in the medium term. Recent announcements made in the Interim Budget, including the Rs 1 trillion corpus for scaling up research and innovation in sunrise domains and the “Rooftop Solarisation” scheme, are steps towards improving the quality of government outlay.