Fiscal Consolidation

By : Neha Dhyani

Updated : May 31, 2022, 8:54

The fiscal deficit is the difference between total disbursements from the consolidated fund of India during a financial year (excluding debt repayments) and total inflows into the fund (excluding debt receipts). It is the amount spent by the government more than its income, expressed as a percentage of GDP.

The term "Fiscal Consolidation" refers to the methods used to reduce the fiscal deficit. To close a deficit, a government usually borrows. It will then have to set aside a portion of its profits to pay off the debt. As the debt grows, the interest burden will grow as well.

Budget 2022

Moreover, 8.09 lakh crore (approximately 20%) of the total government expenditure of over 34.83 lakh crore was spent on interest payments in the FY22 Budget. Debt is a difficult burden to postpone, and the government, at the end of the day, is struggling to find more resources for both capital and revenue expenditures. Uncontrolled budget deficits will stifle economic growth in the long run.

The legality of Fiscal Consolidation in India

Manmohan Singh, the then-Finance Minister, sowed the seeds of Fiscal Consolidation in 1994. In his FY95 budget speech, he emphasised the importance of fiscal discipline and announced a policy to stop monetising the deficit.

The government had been funding its deficit by printing money and issuing ad hoc treasury bills with unfettered access to the Reserve Bank. The Reserve Bank's ability to direct effective monetary policy was harmed. Singh declared that ad hoc treasury bills would be phased out and that the government would henceforth cover its deficit using market borrowings.

As open market borrowings built up to pay the deficit, Yashwant Sinha called for a strong institutional structure to maintain fiscal discipline in his FY01 budget speech. The enactment of the 'Fiscal Responsibility and Budget Management (FRBM) Act, 2003' resulted in the fiscal deficit being limited to 3% of GDP.

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India's Performance post-Fiscal Responsibility and Budget Management

When the Fiscal Responsibility and Budget Management Act (FRBM) was passed, the goal was to keep the fiscal deficit under 3% of GDP by FY08. That, however, never happened. The budget deficit decreased from 5.9% in 2012 to 3.4 per cent in the fiscal year 2019.

It increased to 3.8 per cent in FY20. It was suggested at 3.5 per cent the following year, but the pandemic struck and jumped to 9.5 per cent. It is now predicted to be 6.8% for the current fiscal year, with the government aiming for 4.5 per cent by FY26.

A 3% fiscal deficit currently appears to be a far-fetched possibility. The government amended the FRBM Act regularly to comply with the law.

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Trade-off Between Fiscal Consolidation and Growth

It's a point of contention. Many economists believe that reducing the fiscal deficit is necessary for faster economic growth. They argue that a huge budget deficit will raise borrowings, limiting the government's capacity to spend productively. Increased government borrowing will also squeeze out the private sector in the debt market, resulting in higher interest rates, which will stifle growth.

Other economists claim that Fiscal Consolidation is an expenditure switching process rather than a fiscal compression mechanism. They claim that the initial FRBM Act of 2003 pushed for a change in spending from revenue to capital, laying the groundwork for faster growth. They claim that the FRBM Amendment Act of 2018 dilutes the original Act to the point that it becomes contractionary.

A reduction in the underlying fiscal deficit is referred to as Fiscal Consolidation. It refers to government initiatives (at both the national and sub-national levels) to reduce deficits and debt accumulation. Its goal is not to eliminate fiscal debt. The Fiscal Consolidation and the FRBM Act of 2003 are briefly explained in this article.

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FAQs on Fiscal Consolidation

Q.1. Why is Fiscal Consolidation important?

Announcing Fiscal Consolidation plans and steps requires many countries to repair public finances and maintain market confidence. Its goal is to lower government deficits and debt levels.

Q.2. What Fiscal Consolidation measures has the federal government taken?

The government has made steps for Fiscal Consolidation, such as decreasing the budget deficit to less than 3.5 per cent of GDP and maintaining a debt-to-GDP ratio of roughly 60%.

Q.3. What are the three tools of fiscal policy that aid in Fiscal Consolidation?

The three tools of the fiscal policy that aid in Fiscal Consolidation are:

  • Government Spending
  • Transfer Payments
  • Taxes

Q.4. What measures were taken concerning tax under Fiscal Consolidation?

Some of the measures taken under Fiscal Consolidation concerning taxes were improved tax administration efficiency by minimising tax evasion, boosting tax compliance, and reducing tax avoidance.