The recent Union budget proposed plans to target a fiscal deficit of 6.8 percent of the Gross Domestic Product (GDP) for the coming financial year 2021-2022 and consequently reduce it to 4.5% by financial year 2025-2026. For a developing country like India, the proposed deficit targets seem far from liberal. While the government projects a GDP growth to be around 14.4 percent for the coming year, India could easily accommodate a higher fiscal deficit without increasing its debt-to-GDP ratio as the economy expects to bounce back from the COVID-19 economic setbacks.
India’s fiscal deficit saw a manifold increase from 4.6% of the GDP in 19-20 to roughly 9.5% in 2020-21. This was a rather aberrant increase from the 3.3 percent target projected for the year.
To make up for this reckless expenditure, a 12 percent target would’ve seemed ideal considering the favourable economic climate being forecasted for this year.
There are multiple factors which need to be carefully evaluated to set sight for the fiscal deficit targets a country aspires to achieve. These predominantly include the economic growth rate of the country and its debt-to-GDP ratio.
India’s debt-to-GDP ratio currently stands at nearly 85% which increased last year owing to the economic setbacks our country witnessed due to a pandemic.
Prior to that, India had steadily maintained its fiscal deficit at 68% for the previous 10 years.
It also must be noted that many developed and developing countries have similar or higher debt to GDP ratios. Countries like the US, Japan and Singapore have debt exceeding 100% of their GDP. Countries such as Brazil, United Kingdom and Spain maintain debt amounting to 85-100 percent of their GDP. From that aspect, If we aspire to maintain the respectable current debt-to-GDP ratio of 85% and compute our fiscal deficit targets as per the projected GDP growth numbers of 14.4% disclosed by our Finance Ministry, we arrive at a target of 12.2% of fiscal deficit which we can afford for the following year.
Even if India decides to return to its earlier debt-to-GDP ratio of 68%, it could still afford a fiscal deficit of about 9.8% for the upcoming year, making room for considerable debt-financing.However, it is widely believed that when the government borrows excessively, it crowds out private borrowers like companies, manipulates interest rates and reduces net exports. This could then lead to either higher taxes, higher inflation or both.
With this in mind, the government must tread cautiously and regulate spending from the purview of the inflation trap as the circulating funds could cause the already rocketing rates of inflation to rise further. Hence, it is crucial that the corpus of funds be effectively utilised to increase net economic output, and not just fuel the existing rates of inflation.
Productive financing to boost economic output
Deficit financing must be ideally undertaken in sectors where social gains and slow-reaping benefits are seen or the operating cycle is spread out. For example, large-scale spending on public commons and soft-infrastructure assets in the power, transport and education sectors would slowly accrue benefits without disrupting the economy and would serve beneficial for the functioning of the state. Also, involving competitive private players for such spending would make the process more efficient and cost-effective.
High GDP growth projections for 2021-22 present an unprecedented opportunity to be more proactive in terms of deficit financing. But the effectiveness of this plan is crucially based on how the extra money is utilised and spent. It is now time for India to be bold and effectively manage it’s corpus of funds by wisely regulating expenditure, enhancing productivity, and improving the quality of soft infrastructure in our country.