Budget 2024: Making Sense of India’s Fiscal Deficit

Key Takeaways

• Budget 2023 announced the fiscal deficit target at 5.9% of the GDP.
• There should be focus in the upcoming budget on decreasing India's fiscal deficit. By prioritising strategies to boost revenue while controlling expenditures, the Indian government aims to achieve sustained fiscal consolidation.
• In the upcoming budget, the government is expected to target a lower deficit and lay emphasis on narrowing the fiscal deficit to 4.50% of the GDP by the end of the 2025-26.

Mumbai, 25 January: Imagine you have a monthly income, and you plan your expenses accordingly. However, if you consistently find yourself spending more than you earn, you will have to bridge the gap by borrowing money or using credit. This gap between your income and expenses is similar to a fiscal deficit. The more you borrow to cover this gap, the more it impacts your financial stability in the long run.

In the same way, when a government's total spending exceeds its revenue, it creates a fiscal deficit. The government must borrow money to cover this shortfall, just like an individual needing to borrow money to cover overspending. This borrowing can lead to increased debt and financial challenges for the government, like the challenges an individual faces when relying on borrowing to cover expenses.

Current Year's Fiscal Deficit in India

In Budget 2023, the government announced it would spend nearly ₹45 lakh crore and earn about ₹27 lakh crore in revenues this year. This meant a fiscal gap of about ₹18 lakh crore, which it will borrow to fill.

Because economies grow over time, as does the fiscal deficit. Hence, it needs to be seen as a proportion of the GDP.

For FY24, the government’s projected deficit stands at 5.9 percent of GDP. In FY23, the fiscal deficit stood at 6.4%, which meant that the government’s fiscal situation has improved.

This is understandable because all governments, including India’s, saw a sharp rise in their deficit as they undertook large scale spending to counter the aftermath of the COVID hit. With the pandemic behind us, governments have started to tighten their belts by trying to reduce the deficits.

How to interpret the deficit number?

As noted above, a deficit number can be contextual. During times of economic weakness, governments choose to spend more money to kickstart activity even if it means borrowing more. And as the economy turns around, the money made in the rebound can be reduced to decrease the deficit.

However, because governments need to pay back interest on loans they take, not to mention the principal, economists maintain that the deficit number should not be too high.

In India, the FRBM Act puts limits to how much deficit the government can run up. When the rules were last updated, they had sought a target of 3% that the government should get to by FY21. However, the target was put on hold following the COVID pandemic.

The upside to having a deficit

While the fiscal deficit number should not be too high, a common view is that it shouldn’t be too low either, especially for emerging markets such as India. Think about it: in order to bring down the deficit to say zero, or even get to a fiscal surplus situation (where governments earn more than they spend), either revenues will have to be improved or spending slashed.

Since spending is an aspect that a government can directly control, any immediate reduction in deficit can only be undertaken by spending less. This will have an adverse impact on the economy.

There’s another way to look at this. When the Indian government borrows money, it pays about 6 to 7% interest per year depending on the prevailing yield on the GSec.

Also, when the borrowed money is spent, it creates additional growth, which otherwise would not have been generated.

Depending on whether the money is put directly in the hands of the people (by say paying salaries of government employees) or invested (creating an infrastructure project), it will achieve circulation in the economy depending on the velocity of how it travels.

While economists have models to predict the incremental impact of every additional unit of money spent through multiplier models, it is fair to assume that any additional money spent by taking on a deficit could create quick GDP growth in a country that grows nominally at about 12%. (Nominal growth is inclusive of the rate of inflation.)

To summarise, it is possible that a country can borrow money at 6%, make more money on it, and see its deficit or overall debt position improve as a percentage of GDP.

What needs to be done for a lower Fiscal Deficit in future?

That said, India currently has a higher deficit than desired and the government has said it will target a fiscal deficit of 5.3% in the coming fiscal (FY25) before bringing it down further to 4.5% by FY26.

One of the ways it can do this is by focusing on increasing divestment receipts by selling stakes in state-owned enterprises and Public Sector Units (PSUs). Plus, with improving tax collections through direct and indirect taxes, more and more revenue can be poured in.

Conclusion

Fiscal deficit and budgetary decisions play a crucial role in shaping India's economic landscape. Therefore, the upcoming budget is anticipated to prioritise fiscal consolidation and prudent financial management, with a specific focus on reducing the fiscal deficit below 4.5% of GDP by 2025-26.

Furthermore, there is a need for faster revenue generation, effective expenditure management, and investment in initiatives that drive economic growth while maintaining fiscal discipline.