Budget 2024: Fiscal Consolidation Finally Paying Off, FM Nirmala Sitharaman Must Stay The Course

No doubt, it would involve many tradeoffs between fiscal imperatives and political compulsions -- especially in view of the demands of coalition partners in the new government. But the ramifications could be hugely beneficial.

Already, on May 29, international credit rating agency S&P Global upgraded India's sovereign rating from positive to stable after a gap of 14 years, saying it reflected "continued policy stability, deepening economic reforms, and high infrastructure investment will sustain long-term growth prospects."

Further, the agency said: "Along with a cautious fiscal and monetary policy that diminishes the government's elevated debt and interest burden while bolstering economic resilience, could lead to a higher rating over the next 24 months.”

Fiscal consolidation has been the hallmark of the Union budget since the stimulus rollout during the COVID pandemic. Contrary to the response of many countries, the Union finance ministry refrained from splurging.

Instead, the government sought to target specific economic segments like micro and small enterprises (of MSMEs) with the ECLGS scheme, yielding a very high return on investment (RoI), which had since become a reference benchmark for the quality of fiscal intervention. With team at the finance ministry largely unchanged from the previous regime, it is fair to expect continuity in budget strategy. 

The Centre's fiscal deficit (FD) has steadily declined from 9.2 per cent of GDP in FY2020-21 -- the pandemic year -- to 5.6 per cent in FY 2023-24. The Interim Budget, presented in February, pegged it at 5.1 per cent for FY 2024-25, but it will likely see a significant scale-back, when the finance minister unveils the full budget on Tuesday. So will the final numbers for FY2023-24, because revenue collections have been more robust than expected and spending is under control.

The exchequer has already netted close to Rs 2.5 lakh crore in dividend payments from the Reserve Bank of India and public sector banks and enterprises -- almost two and half times of what the Interim Budget had estimated. This has significantly expanded the headroom the government now has to spend more than it had proposed beforethe elections.

Moreover, the sustained bull rally in the stock market will help the government raise more money from income tax, due largely to capital gains from share market sales and higher Securities Transactions Tax (STT).

Dividend receipts and tax revenues, taken together, could top the Interim Budget estimates by 5.5 per cent to 6 per cent of total expenditure and about 0.8 per cent to 0.9 per cent of nominal GDP. 

Hence, if the government chooses to spend more -- say up to half percent of GDP -- to pump-prime the economy, the fiscal deficit for FY2024-25 could still stay well below 5 per cent of GDP, as against the estimate of 5.1 per cent projected in the Interim budget. Some of the expenditure heads that may see larger allocation include PM-KISAN, MNREGA, PM-AWAS, Gram Sadak, rural drinking water.

Next Steps

The government will still be in a comfortable position to pursue fiscal consolidation and further reduce the fiscal deficit from the target 4.6 per cent of GDP in FY 2025-26 to an aspirational 4.2 per cent to 4.3 per cent. Together with a projected state governments’ aggregate fiscal deficit of 2.7 per cent to 2.8 per cent, this could bring the combined fiscal deficit of the Centre and the states close to the 7 per cent of GDP goal set by the ratings agency for a ratings upgrade. 

Second, as a condition for the upgrade, it is necessary to mention the shift in spending focus from the long-standing (and rising) revenue expenditures to capital expenditures, which has been a notable characteristic of the recent budgets.

Much has been written on this pivot, which has been emphasised as a harbinger of state led rising productivity of private enterprise. While major signs of this are still awaited, initial trends suggest that the strategy is working, with private sector capex accelerating in FY2023-24, although still largely concentrated in relatively few segments. 

Why do we keep talking so much about fiscal consolidation and the shift from revenue spends to capex spends? About 68 per cent of gross taxes collected by the Centre remains with the Union government after devolution of 42 per cent to states as mandated by the Finance Commission.

Of this, an average of 45 per cent over the past five years has been spent on interest payments on existing debt. Salaries and pensions account for another 16 per cent to 18 per cent. Add defence salaries, it goes up to to 22 per cent to 23 per cent. Hence, about 68 per cent of the outlays are committed payments. In addition, there are subsidies -- about 16 per cent, which are partially committed.

All taken together, these account for almost 84 per cent of the centre’s tax receipts, leaving just 15 per cent for development and other revenue expenditures. The rest have to be covered through additional borrowing, further adding to interest payments. This is of major fiscal concern. 

To gauge this evolving stress on the centre’s fiscal position, we need to monitor two other deficit indicators, the revenue and primary deficits. The latter is particularly important, being the difference between the fiscal deficit and interest payment, and indicative of how much of new borrowings are required, other than those for interest payments. This had fallen sharply till FY 2018-19, but expectedly gone up during the COVID years and, very worryingly, is now coming down only very slowly. 

In conclusion, the budget exercise will necessarily involve multiple expenditure tradeoffs, given the considerations on account of the political economy. However, Sitharaman must not lose sight of the primary objective of fiscal consolidation, which will have multiple beneficial ramifications spread widely into multiple economic domains, which will help to sustain high economic growth in the medium to long term.

And in the process, the prospect of a sovereign rating upgrade that has eluded India for decades will eventually become a reality.

(The author is a Mumbai-based independent economist. He was until recently the Chief Economist of Axis Bank. Views expresed are personal)