India is currently facing challenges in achieving its fiscal deficit target of 4.5% of GDP by the fiscal year 2025-26. Analysts, including those from Fitch Ratings, have expressed concerns regarding the feasibility of this goal. The fiscal deficit, which soared to 9.5% of GDP during the COVID-19 pandemic, remains above the medium-term objective despite government efforts to reduce it.
About the Fiscal Glide Path
The fiscal glide path refers to a strategic plan established by the government to gradually decrease its fiscal deficit over time. This approach is crucial for maintaining fiscal responsibility while accommodating economic challenges. The NK Singh Committee first proposed this concept, aiming to reduce the fiscal deficit to 3% of GDP by FY20, with further reductions planned for subsequent years. However, the economic slowdown and pandemic disruptions have complicated these targets.
Current Economic Challenges
The ongoing economic slowdown has adversely affected tax collections and other revenue streams. This situation has raised concerns that meeting the 4.5% target for 2025-26 may be unattainable unless corrective actions are implemented. The government must navigate these challenges to maintain its fiscal discipline.
Deviating from Fiscal Targets
The NK Singh Committee’s framework includes an escape clause. This clause permits a deviation of up to 0.5% of GDP in extraordinary circumstances. Such flexibility allows the government to exceed its fiscal deficit target in times of economic distress or unforeseen events, ensuring a balanced approach to fiscal management.
Economic Impact of Fiscal Deficits
High fiscal deficits can lead to inflationary pressures. If the government finances its deficit by printing money or excessive borrowing from the central bank, it increases the money supply. This can drive up inflation, erode purchasing power, and reduce consumer spending. Additionally, financing through market borrowing raises demand for funds, potentially increasing interest rates. Higher interest rates can further exacerbate inflation by increasing borrowing costs for businesses and consumers.
Future Outlook
The path to achieving a fiscal deficit of 4.5% of GDP by 2025-26 is fraught with challenges. The government must balance fiscal discipline with the immediate economic needs of the country. How this balance is achieved will be critical for India’s economic stability and growth in the coming years.
Questions for UPSC:
- Examine the implications of fiscal deficits on long-term economic growth.
- Discuss the role of the NK Singh Committee in shaping India’s fiscal policy.
- Critically discuss the impact of economic slowdowns on government revenue and fiscal targets.
- With suitable examples, discuss how inflation can affect consumer behaviour during periods of high fiscal deficits.
Answer Hints:
1. Examine the implications of fiscal deficits on long-term economic growth.
- High fiscal deficits can lead to increased borrowing, raising interest rates.
- Elevated interest rates discourage private investment, stunting economic growth.
- Fiscal deficits can trigger inflation, reducing purchasing power and consumer spending.
- Persistent deficits may lead to a loss of investor confidence, impacting foreign investment.
- Long-term deficits can limit government capacity to fund essential services and infrastructure.
2. Discuss the role of the NK Singh Committee in shaping India’s fiscal policy.
- The NK Singh Committee proposed a structured fiscal glide path for deficit reduction.
- It aimed to bring down the fiscal deficit to 3% of GDP by FY20 and further reduce it.
- The committee emphasized fiscal discipline while allowing flexibility during economic distress.
- Its recommendations have guided subsequent fiscal policies and budgetary frameworks.
- The committee’s approach balances long-term fiscal responsibility with immediate economic needs.
3. Critically discuss the impact of economic slowdowns on government revenue and fiscal targets.
- Economic slowdowns lead to decreased tax collections, impacting government revenue.
- Lower revenue makes it challenging to meet fiscal deficit targets set by the government.
- Reduced consumer spending during slowdowns further exacerbates revenue shortfalls.
- Government may resort to increased borrowing, worsening fiscal deficits.
- Long-term economic stagnation can lead to structural issues in revenue generation.
4. With suitable examples, discuss how inflation can affect consumer behaviour during periods of high fiscal deficits.
- High inflation erodes purchasing power, leading consumers to cut back on spending.
- For instance, rising prices for essentials like food and fuel strain household budgets.
- Consumers may shift towards cheaper alternatives or delay purchases.
- Inflation can lead to increased savings as consumers become uncertain about future prices.
- In extreme cases, hyperinflation can cause panic buying, disrupting normal market behavior.
