New Focus of India’s Fiscal Policy

Source: The post new focus of India’s fiscal policy has been created, based on the article “FRBM rethink: Aim for clarity in India’s fiscal policy framework” published in “Live Mints” on 31st July 2024

UPSC Syllabus Topic: GS Paper3-Economy- mobilization of resources

Context: The article discusses India’s shift to a new fiscal policy focused on reducing public debt as a percentage of GDP. It emphasizes sustainable public finances over the medium term, rather than just annual fiscal deficits, to ensure economic stability.

For detailed information Fiscal Federalism in India read Article 1, Article 2

What is the New Focus of India’s Fiscal Policy?

1. Shift in Focus: India aims to move from controlling the annual fiscal deficit to reducing public debt as a percentage of GDP.
2. Current Debt Levels: India’s public debt is around 58% of GDP, 18 percentage points higher than the ideal level.
3. Approach to Debt Reduction: The government plans to lower this ratio by achieving higher nominal GDP growth compared to borrowing costs and cutting the primary deficit.
4. Historical Context: India has relied on high growth to manage public debt but this approach may not be sustainable long-term.

How Will This Impact the Economy?

1. Debt Reduction Goal: The government aims to reduce public debt from the current 58% of GDP.
2. High Growth: Historically, India has relied on high nominal GDP growth to manage debt.
3. Fiscal Management: Both high growth and reduced government borrowing costs help lower debt.
4. Primary Deficit Cuts: The government may need to cut its primary deficit to achieve debt reduction.

What Are the Challenges?

1. Economic Growth and Borrowing Costs: Effective debt reduction depends on maintaining a high nominal GDP growth rate compared to the cost of government borrowing. Historically, India has relied on high growth rates and relatively low interest rates to manage debt.
2. Fiscal Prudence: The N.K. Singh committee highlighted that relying solely on high growth is not enough. Fiscal policy must also actively work to reduce the primary deficit.
3. Communication: Shifting focus from annual deficit targets to a sustainable public debt ratio is complex and requires clear communication to the private sector.

What Should be Done?

1. Shift Focus to Public Debt Ratio: The government should prioritize reducing public debt as a percentage of GDP, currently around 58%, rather than focusing solely on the annual fiscal deficit.
2. Promote Economic Growth: Ensure that nominal GDP growth exceeds the cost of government borrowing to naturally reduce the debt ratio. This is important as high growth historically helped India manage its debt.
3. Implement Fiscal Prudence: Adopt policies to cut the primary deficit, as the N.K. Singh committee highlighted that relying solely on high growth is not sustainable for debt reduction.
4. Establish a Fiscal Council: Create an independent body to provide transparent and credible public debt estimates, similar to the US Congressional Budget Office, to enhance the credibility of fiscal policy.
5. Improve Communication: Clearly convey the new fiscal strategy to the private sector to maintain confidence and predictability in government budgeting.
6. Utilize Flexibility: Use the escape clause in the Fiscal Responsibility and Budget Management law during economic crises to support the economy without rigid borrowing limits.

Question for practice:

Examine how India’s shift in fiscal policy from focusing on the annual fiscal deficit to reducing public debt as a percentage of GDP impacts economic stability and long-term sustainability.