RBI research about economic growth and fiscal consolidation-Recalibrating spend

Source: The post implication of recent Supreme Court decision has been created, based on the article “Recalibrating spend: RBI paper redefines the capex-revenue debate” published in “Business standard” on 23rd February 2024.

UPSC Syllabus Topic: GS Paper 3- Indian Economy and issues relating to planning, mobilisation of resources, growth, development and employment.

News: The article discusses how the Indian government’s budget focuses on reducing debt and improving spending on long-term growth areas like technology, health, and education. It highlights RBI research on how this approach can lead to economic growth despite short-term challenges.

What are the government’s plans for fiscal deficit and borrowing?

Fiscal Deficit Goal: The government intends to bring the gross fiscal deficit down to 5.1% of GDP for FY25, a consolidation from the previous fiscal year.

Limiting Foreign Borrowing: Emphasis is on reducing reliance on external borrowing, focusing on domestic fiscal management.

Increase in Tax-GDP Ratio: There’s been a rise in the tax-GDP ratio, from 10.1% in FY14 to 11.7% in FY25, reflecting improved tax revenue efficiency.

Prioritizing Capital Expenditure: The government is shifting its spending towards capital expenditure over routine revenue expenses, indicating a focus on long-term infrastructural investments.

Developmental Expenditure (DE): A broader approach to capital expenditure is proposed, with DE including allocations for health, education, and digitization, expected to be around 4.2% of GDP in FY25.

What does RBI research say about economic growth and fiscal consolidation?

Linking Fiscal Consolidation and Growth: The Reserve Bank of India’s research explores how fiscal consolidation can positively impact economic growth.

Redefinition of Capex: The paper suggests a broader approach to capital expenditure by considering developmental expenditure (DE), which includes spending on health, education, skilling, digitisation, and climate-risk mitigation.

Growth Impact of DE: A 1% increase in real DE is expected to produce a cumulative 5% rise in GDP over four years.

Employment and Productivity: Increasing employment by 5% in high labor productivity sectors, like chemicals, financial services, and transport, could add more than 1 percentage point to GDP growth between 2024 and 2031.

Digitisation and Energy Efficiency: The research highlights that digitisation and reduced energy intensity can enhance growth by improving labor and capital technology.

Balancing Short-term and Long-term Effects: The study acknowledges short-term pains, like a sharp rise in debt-GDP ratio, but emphasizes that long-run gains outweigh these costs.

Way forward

Moving forward, the government should continue focusing on developmental expenditure in areas like health, education, and digitisation. This approach, as RBI research shows, can lead to a significant GDP increase. Investing in high-productivity sectors and enhancing labor skills are essential for sustainable economic growth and long-term fiscal health.

Question for practice:

Evaluate the effectiveness of the Indian government’s approach to fiscal deficit reduction and increased developmental expenditure in fostering long-term economic growth, referencing the findings from the RBI research.