There has been considerable progress in the country in terms of macroeconomic stability, efficient financial sector, and digital infrastructure. In fact, after a decade-long problem of distressed balance sheets of both the corporates and banks and non-banking financial companies, the financial sector looks healthy. The corporates are in a consolidation phase and poised to undertake additional investments due to the ‘crowding in’ effect of higher levels of public investment in infrastructure.
Although shocks like deficient rainfall, volatility in oil prices, international capital flows and global hostilities do have adverse impacts on the economy, the country has acquired a certain degree of immunity, and the intensity is much less than it was in the past.
There is also a reasonably high degree of political and policy certainty, which adds to the investment climate. With many multinationals adopting a China+1 strategy, right signalling and further liberalisation of the foreign trade and investment regime and freeing of factor markets can attract greater investments. Some of the important reforms needed to create the enabling investment climate are discussed below.
An important feature of the post-pandemic recovery has been an attempt by the government to increase capital expenditure while trying to achieve fiscal consolidation.
The fiscal deficit reached an unprecedented 13.2 per cent of GDP in 2020-21 and outstanding government liabilities peaked at 90 per cent. From this position, the next two years have seen a serious attempt by the government to reduce both deficit and debt to an estimated 9 per cent and 83.9 per cent, respectively, in 2023-24. During the last two years, the Union government has attempted to substantially compress the fiscal deficit while making additional allocations to infrastructure spending. The central government fiscal deficit is budgeted to be reduced to 5.9 per cent in 2023-24 and by 2025-26, it is targeted to be 4.5 per cent.
Achieving the aggregate fiscal deficit of 6 per cent of GDP and the debt target of 59 per cent of GDP recommended by the 14th Finance Commission is, however, no longer within the realm of feasibility. In fact, in its Article IV consultation document, the IMF (2023) has projected that in the worst-case scenario, if the fiscal slippages due to various shocks seen during 2000-2020 materialise, the government debt could exceed 100 per cent of GDP.
While the probability of such a large slippage is not very high, it underlines the importance of reaching the medium-term fiscal deficit target of 7 per cent of GDP (4.5 per cent at the Centre and 2.5 per cent at the states level) by 2025-26 and thereafter, further fiscal tightening would rebuild buffers at a faster pace to safeguard against shocks.
This will, in addition, reduce the debt-servicing burden, which currently is equivalent to one-third of the tax revenue to create more fiscal space for spending on infrastructure, health, and climate change mitigation and adaptation. An aggressive attempt at fiscal consolidation toward sustainable levels of deficit and debt while continuing to spend more on infrastructure is critical to creating an enabling environment by ‘crowding in’ private investment.
Like in most other countries, the rule-based fiscal policy over the last two decades has not guaranteed fiscal sustainability. There have been frequent changes in the rules, deviations from the targets, suspension of the rules, and resorting to exceptional clauses, and this has raised questions on credibility.
With deficits and debt reaching unprecedented levels, the time is now opportune to design new rules based on the lessons from past experiences. Effective implementation of rule-based fiscal policy must be done within the overall system of scientific budget management and a realistic medium-term fiscal policy.
The time is opportune for working out the new set of fiscal rules specifying the deficit and debt targets as the objective conditions have significantly changed from the time the rules were first framed in 2004-5. The household sector’s financial savings have steadily declined from 10 per cent of GDP in 2003-4 to 5.1per cent in 2022-23. Given the reduced borrowing space, the continued high volume of withdrawal of household savings by the government would significantly reduce the borrowing space for private investments and drive up the borrowing cost.
A more scientific public finance management system imbibing the technological advances and adoption of an accrual accounting system is important to ensure timely and transparent budget implementation.
Similarly, the creation of an independent institution like the Fiscal Council is important to evaluate the realism of the budget forecasts, timely monitoring and reporting of the budget implementation issues, and costing of the various liabilities involved in implementing the various policy pronouncements made and schemes introduced from time to time.
Working out a medium-term plan for fiscal consolidation is important not merely to compress fiscal deficit and debt but also to protect more productive spending on physical infrastructure and human capital.
India has a demographic advantage, but an overwhelming proportion of the working-age population does not have the education and skills required to participate productively in organised manufacturing and service sectors. Equally important is the fact that the female labour force participation in the country is low at 32.8 per cent in 2022. The wages in organised manufacturing and service sectors are six times higher than in small enterprises, and preparing the workforce to avail opportunities in these sectors requires significant investments in education, healthcare and skilling.
Debt reduction will reduce interest payments, but a more aggressive reduction in fiscal deficit is possible only when the proliferating subsidies and transfers are phased out.
On the tax side, with the firming up of the technology platform, the compliance with GST has shown a steady improvement. The time is opportune for the second-generation reforms, by including petroleum products and electricity in the tax base, phasing out many items in the exempted list, and simplifying the tax, reducing the number of rates.
The application of modern technology has facilitated targeted scrutiny of taxpayers and that should help in improving voluntary compliance with the tax. Equally important is the need to revisit the role of the State and aggressively privatise all commercial enterprises run by the government and use the proceeds either to retire debt or to make the much-needed spending on public infrastructure.
(The writer is a former Director, National Institute of Public Finance and Policy and Member, Fourteenth Finance Commission. This is the second of a three-part series)