On fiscal deficit: The turn of the Centre

News: The Union Finance Minister Nirmala Sitharaman will present her 4^th consecutive Budget in just about eight weeks from now.

It is expected that Ms Sitharaman would achieve a 2.7 percentage point reduction in the deficit from 9.5% in 2020-21 to 6.8% in 2021-22.

This steep reduction will provide a lot of flexibility in managing the Budget not only for 2022-23, but also for the following couple of years.

Even targeting a reduction of just about 0.75 percentage point in each of the next four years will be sufficient to stay ahead of the target of 4.5% by 2025-26.

But it would become worse if she adopts a slow process of fiscal consolidation in the coming years, taking advantage of the easy target for the Centre by 2025-26. That is because the condition of the state finances does not look good.

In this context, it is said that Centre should take more responsibility by achieving a faster pace of fiscal consolidation and give  states more room to cut down their deficit reduction.

What were the revised fiscal deficit targets for the centre and state?

Centre: Need to reach a fiscal deficit level of 4.5 per cent of gross domestic product (GDP) by 2025-26 from the current level of 9.5 per cent.

States: The target for the combined fiscal deficit of the states has been set at 4 per cent of GDP for 2021-22. Further, they must reach a deficit level of 3 per cent of GDP by 2023-24.

Why states should be given more room to cut down their deficit reduction?

Firstly, the states have been given a tougher target of fiscal consolidation. They must reach a deficit level of 3 per cent of GDP by 2023-24, while the Centre would reach 4.5 per cent two years later in 2025-26.

It appears unfair that while the Centre should enjoy a more relaxed fiscal consolidation schedule, the states should be expected to be more fiscally responsible.

Secondly, there is also an equity issue. Before the pandemic struck, the states kept their combined fiscal deficit below the target of 3 per cent, which gave the Centre some space to extend the fiscal deficit. This also helped to bring down the overall government deficit. Now, it is time for the Centre to return the favour.

What is the way forward?

The states should be given a longer period of time to cut down their deficit reduction to 3 per cent of GDP.

Source: This post is based on the article “The turn of the Centre” published in Business Standard on 8^th Dec 2021.