Budget should balance growth and public debt

The two topics provide the background of fiscal policy since July 2019. First, the credibility of the budget has improved over the last four years, thanks to more transparent accounting as well as more reasonable assumptions on economic growth. Such credibility matters when the bond market absorbs the new budget numbers and decides the interest rates on government bonds.

Second, public finances have been hit hard by two exogenous shocks that no government could control: the post-March 2020 dislocation during the Covid pandemic, followed by the energy price spike following the Russian invasion of Ukraine in February 2022. These two shocks messed up. The financial condition of most countries has improved, and India has been no exception. However, the Indian fiscal response to the pandemic was more cautious than that of many other large economies, leading to inflation levels not seen in those countries for several decades. The Indian finance minister had budgeted a fiscal deficit of 6.4% of gross domestic product (GDP) for the fiscal year ending in March. There is a high probability that this key fiscal target will be met, despite the fact that the subsidy bill will exceed the budgeted target. 2 trillion. The government’s decision to extend the provision of free food under the Pradhan Mantri Garib Kalyan Anna Yojana for most of this financial year as well as to protect farmers from rising global fertilizer prices are the main reasons for the high subsidy bill.

However, this additional expenditure will not increase the fiscal deficit as the net tax collection is expected to increase almost identically this year above the budgeted target. The main reason for this extra money flowing into the tax coffers is the higher growth in nominal GDP; It will be lower in the next financial year as economic growth loses momentum while price pressures ease. Thus the increase in tax collection will be more modest in 2023-24.

The temptation to cut taxes on income earned by the middle class ahead of an election year is tempting. However, it would be more prudent to keep tax rates unchanged for now and go for a more effective overhaul of the direct tax code later. This includes lowering tax rates as well as reducing the various perverse exemptions that people with good accountants can play up. The long-term goal of Indian tax policy should be to collect more direct taxes while reducing the burden of indirect taxation, which is more regressive.

The anticipated economic slowdown reduces the space for sharp fiscal reforms in the fiscal year starting in April. The finance minister had earlier said that the fiscal deficit of the central government would be brought down to 4.5% of GDP by the end of 2025-26. That would be 1.9 percentage points over three years. The current state of the economy—as consumer demand slows, private sector investment spending remains weak and exports falter—suggests that the government should pursue fiscal reform asymmetrically, 50 basis points in the next fiscal year. marks and then marks in subsequent two years on 70 basis.

Such modest fiscal reform may be manageable, despite weak growth in tax collections. How? The restructuring of the food subsidy announced a few weeks back will result in substantial savings to help balance the fiscal. A lower subsidy bill may account for most of the desired fiscal reform, as long as tax collections keep pace with modest growth in the underlying economy. However, this modestly optimistic assessment does not take into account the sudden increase in government spending for select interest groups or the hurried tax cuts in the months before the next general election.

A modest fiscal correction of around 50 or 60 basis points comes with two concerns. First, despite a surprising improvement in overall state government finances, the combined fiscal deficit of both the Center and the states could be around 8.5% in 2023-34. At a time when bank credit to the private sector is rising, and there is anecdotal evidence of some companies moving funds from overseas to the domestic market as a result of narrowing interest rate differentials, consolidated government borrowing will absorb most households. Available pool of household financial savings of Rs. Bond markets will remain cautious. The Reserve Bank of India may have to prepare to buy government bonds as part of its open market operations, at a time when it is trying to run a tight monetary policy. It is a difficult coordination task.

Second, the overarching task of fiscal management in any economy is not the annual deficit target, but the stabilization of the public debt ratio. The shock of the pandemic pushed Indian public debt to nearly 90% of GDP, the highest it has ever been. It has now come down a bit, but is still around 15 per cent above what is considered comfortable. Interest payments on this debt already soak up nearly half of the central government’s net tax collection, leaving less money for public goods, infrastructure, social sector spending and defence. (Defense spending needs to increase in the coming decade anyway as the Chinese threat to our borders intensifies.)

Public debt dynamics will need to be tracked closely. The government continues to borrow at interest rates that are less than the growth of the economy in nominal terms, meaning there is less pressure on the government to address its primary imbalance, or the fiscal deficit minus interest payments. In its recent review of the Indian economy, the International Monetary Fund estimated the debt-fixed primary deficit at 2.3% of GDP. This number will be worth watching on 1 February.

Niranjan Rajadhyaksha is the CEO and Senior Fellow of Earth India Research Advisors and a member of the Academic Advisory Board of the Meghnad Desai Academy of Economics.