24 March 2025 : Daily Answer Writing

Q1) Highlighting the factors contributing to high fiscal deficit in India, discuss the potential consequences of such deficit and suggest measures to ensure fiscal consolidation. (15 marks, 250 words)

Fiscal deficit represents the disparity between a government’s revenue and expenditure. When expenditures surpass revenues, the government must either borrow funds or liquidate assets to cover the deficit. Presently, the government has adopted a new overarching strategy for fiscal consolidation, aiming to achieve a fiscal deficit-to-GDP ratio of ‘below 4.5%’ by 2025-26.

FACTORS CONTRIBUTING TO HIGH FISCAL DEFICIT:

1. Expenditure related to Public Health and Social Safety: Covid-induced disruptions forced governments to borrow more – to fund additional public health and social safety net expenditure requirements – amid a drying up of revenues.
2. Revenue Shortfalls: The government had raised the target for direct tax collection in FY24 (April 2023 to March 2024) to Rs 19.45 lakh crore, while for indirect taxes, the target was lowered to Rs 14.84 lakh crore in the revised estimates (RE). This shows that the government had to reduce the indirect tax target due to its year-on-year faltering nature, affecting the overall fiscal revenue.
3. Subsidies: Subsidies on items such as food, fertilizers, and fuel have been a major expenditure component. In 2024-25, the total expenditure on subsidies is estimated to be Rs 4,09,723 crore, a decrease of 7% from the revised estimate of 2023-24. Though the amount spent on subsidies has seen a drastic reduction (6%), the overall burden on the government remains unaffected.
4. Stimulus Measures: To mitigate the pandemic’s economic impact, the government announced stimulus packages amounting to around ₹29.87 lakh crore (15% of GDP) over FY 2020-21 and FY 2021-22.
5. Debt Servicing: India’s interest payments on public debt have been significant. In FY 2021-22, interest payments accounted for over ₹8.5 lakh crore, approximately 18% of total central government expenditure.
6. External Factors: India’s reliance on imported crude oil affects its trade balance and fiscal deficit. As of recent data, India imports over 80% of its crude oil requirements, exposing the economy to global oil price fluctuations.
7. Populist Measures: State governments reportedly announced subsidies and populist schemes over Rs 1 lakh crore in 2022. For example, the recent  flip-flop by states on the Old Pension Scheme (OPS) is a good example of governments pursuing populist agendas that can have grave tax burdens on upcoming generations.

CONSEQUENCES OF HIGH FISCAL DEFICIT

1. Continuous fiscal deficit and slippage leads to crowding out effect and further dragging down economic activity in the form of lower consumption and production.
2. Resorting to monetizing the deficit to balance the fiscal deficit leads to negative effects such as inflation.
3. Twin deficits hypothesis: According to the “twin deficits hypothesis”, an increase (a decrease) in the fiscal deficit causes an increase (a decrease) in the current account deficit through the exchange rate and interest rate channels.
4. The fiscal vicious circle: a drastic cut in overall public expenses and increase in taxation leads to a reduction in active demand, the reduction of production and employment and a decrease in public and insurance/retirement fund income.
5. Currency depreciation: Continuous borrowing by the government will lead to fall in the sovereign credit rating of the country, thereby leading to depreciation of currency in the country. 

WAY FORWARD 

1. Fiscal Discipline and Consolidation: It is imperative for the government to progressively reduce the fiscal deficit-to-GDP ratio, as mandated by the FRBM Act, to ensure sustainable public finances. 
2. Focus on capital expenditure: Capex spending brings increased money multiplier effect when compared to revenue expenditure during fiscal consolidation. The finance minister said that every Rs 1 spent on capex has a multiplier effect of Rs 2.45 worth of multiplier in the immediate year, while Rs 1 spent on revenue expenditure gives 45 paise multiplier effect in the immediate year. 
3. Enhancing Revenue Mobilisation: To bolster revenue, there is a need to strengthen tax administration and compliance, thereby broadening the tax base and enhancing revenue collection efficiency. 
4. Rationalising Expenditures: Conducting a comprehensive review of government expenditures is critical to identify inefficiencies and subsequent measures like prioritizing spending in vital sectors like healthcare, education, and infrastructure and curtailing non-essential spending are essential for a stable, debt-free economy. 
5. Debt Management Strategies: A public debt management agency (PDMA) is an independent and specialized institution that is responsible for managing the public debt portfolio of the central and state governments. PDMA can help in reducing the fiscal deficit in a country.
6. Transparency and Accountability: Enhance transparency in fiscal operations and accountability in budget execution to ensure efficient allocation of resources and prevent fiscal leakages. 

A Fiscal Deficit of value less than 4% is considered healthy for the economy, and anything more than 4% needs to be followed by measures to increase revenue or contain expenditure within limits. However, it’s essential to strike a balance between short-term stabilization efforts and long-term structural reforms to achieve sustainable fiscal outcomes.

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