For Prelims:

• Fiscal Deficit: Understanding fiscal deficit targets and their implications for economic stability.
• Gross Domestic Product (GDP): Relationship between fiscal deficit, debt, and GDP growth.
• Fiscal Responsibility and Budget Management (FRBM): Key targets and their significance.

For Mains:

• GS III: Economic Development: Fiscal Stability and Growth - Balancing Fiscal Deficit and Debt

Highlights of the Article:

• The Union Budget 2024-25 aims to reduce fiscal deficit to 4.5% of GDP by 2025-26.
• The government plans to focus on maintaining a declining path for debt-to-GDP ratio from 2026-27 onwards.
• Concerns raised about abandoning the FRBM 2018 debt-GDP target of 40% for the central government.
• Lower household financial savings (5.3% of GDP in 2022-23) limit available investible surplus.
• High ratio of interest payments to revenue receipts (38.4% average during 2021-22 to 2023-24) for the central government.

Context: The article discusses the challenges of maintaining fiscal prudence in India, highlighting the trade-offs between fiscal deficit, debt-to-GDP ratio, and private sector investment. It emphasizes the need to stick to a 3% of GDP fiscal deficit limit for the central government, given the current lower levels of household financial savings.

UPSC EXAM NOTES ANALYSIS

1. Budget and Fiscal deficit

• Beginning in 2026-27, the government aims to manage the fiscal deficit each year to ensure a gradual reduction in central government debt as a percentage of GDP. According to the Budget speech, the fiscal deficit is expected to drop from 4.9% in 2024-25 to 4.5% in 2025-26.
• With these fiscal deficit levels over two years, the debt-to-GDP ratio is projected to be around 54% by 2025-26, assuming nominal GDP grows by 10.5% annually.
• Beyond that, the government plans to continue reducing the debt-to-GDP ratio without specifying a precise target or timeline, effectively abandoning the 2018 Fiscal Responsibility and Budget Management (FRBM) goal of reducing central government debt to 40% and combined government debt to 60%.
• It is projected that with nominal GDP growth between 10%-11%, the debt-to-GDP ratio can be lowered consistently while maintaining a fiscal deficit of 4.5%.
• At this rate, the debt-to-GDP ratio is expected to reach 48% by 2048-49, continuing its downward trend. Similarly, state governments, under their Fiscal Responsibility Legislations (FRLs), have set a fiscal deficit target of 3% of their Gross State Domestic Product (GSDP).
• However, they might also shift their focus from meeting specific targets to simply reducing their debt-to-GSDP ratios. If both central and state governments maintain average fiscal deficit-to-GDP ratios of 4.5% and 3%, respectively, the combined fiscal deficit could average 7.5% of GDP over several years.
• Although this fiscal path would lead to a declining debt-to-GDP ratio, it would limit the availability of investible surplus for the private sector unless the current account deficit increases to unsustainable levels.
• The Twelfth Finance Commission emphasized that the investible surplus for the private and public sectors beyond government can be derived from the household financial savings and foreign capital inflows remaining after government borrowing.
• The Commission noted that household savings amounting to 10% of GDP, combined with a current account deficit of 1.5%, would support a government fiscal deficit of 6%, with 4% for the private sector and 1.5% for public enterprises.
• Recently, however, household financial savings have declined. In 2022-23, household savings dropped to 5.3% of GDP, compared to an average of 7.6% over the previous four years, excluding the COVID-19 period.
• With 5.3% household savings and approximately 2% from foreign capital, the available investible surplus of 7.3% is entirely consumed by the fiscal deficits of central and state governments, which total around 7.5% of GDP. An increase in fiscal deficits would only be feasible if household financial savings rise

2. Sustainable debt and fiscal deficit

• There is a straightforward mathematical link between the fiscal deficit and the debt-to-GDP ratio. To lower the debt-to-GDP ratio, adjustments need to be made to the fiscal deficit-to-GDP ratio, which essentially reflects the year-over-year change in the debt-to-GDP ratio.
• Since 2003, India has implemented a fiscal responsibility framework, with both the central and state governments adhering to Fiscal Responsibility Legislations (FRLs) that outline appropriate combinations of debt-to-GDP and fiscal deficit-to-GDP ratios.
• In India's case, if the debt-to-GDP ratio remains elevated compared to the benchmarks set by the FRLs of the Centre and States, the proportion of interest payments relative to revenue will also remain high.
• This limits the government’s ability to fund non-interest expenditures. The ratio of the Centre’s interest payments to revenue receipts (excluding tax devolution) dropped to 35% in 2016-17 but has since risen to an average of 38.4% between 2021-22 and 2023-24.
• When considering total central government revenue receipts, including transfers such as tax devolution and grants, this ratio has averaged 51.6%

 3. Global Comparision

• Many countries have a much higher government debt-to-GDP ratio than India, yet their interest payments as a percentage of revenue are significantly lower. For instance, from 2015 to 2019, the interest payment to revenue ratio averaged 5.5% in Japan, 6.6% in the United Kingdom, and 8.5% in the United States, according to the International Monetary Fund. In contrast, India’s average ratio was 24% during 2015-16 to 2019-20, with the Centre’s post-transfer ratio at 49%.
• Although recent discussions emphasize the debt-to-GDP ratio as a key policy focus, there has been no clear target or timeline set for India to reduce this ratio from its current level. The challenge in macroeconomic stabilization is evident when major disruptions, like the COVID-19 pandemic, cause the debt-to-GDP ratio to surge rapidly—in this case, from 50.7% in 2019-20 to 60.7% in 2020-21 in just one year.
• However, restoring the debt-to-GDP ratio to pre-pandemic levels has been a much slower process, and progress remains insufficient. Adjustments in debt-to-GDP ratios following economic shocks tend to be uneven, with governments often delaying necessary reductions while continuing to incur high interest payments relative to revenue.
• Encouraging private investment becomes difficult if there is limited investible surplus. Given the current decline in household financial savings, the central government should maintain a fiscal deficit limit of 3% of GDP. A clear strategy is needed to achieve this target, as any deviation could lead to fiscal irresponsibility