India's fiscal future: Lots done also means there is more to do

Spending quality has improved. Yet, led by the Centre, the fiscal deficit must be lowered to support a new private capex cycle

- PRANJUL BHANDARI

India’s fiscal finances are in better shape today than in the past in terms of spending quality. That’s because capital spending, like on roads and rails by the central government, has risen appreciably. At the same time, the states’ fiscal deficit is under control, and broadly at pre-pandemic levels.

And yet, some worries remain. Public sector borrowing is in double digits. Much of the planned fiscal consolidation by the central government— from 6.4% of GDP in 2022-23 to a 4.5% target in 2025-26—is pending. Past experience shows this gets harder in the outer years, as tough decisions need to be made. For instance, should capex be cut in order to lower the fiscal deficit? Meanwhile, some spending commitments have risen, for instance the extension of the free food scheme.

Let’s look first at the current year. There are several challenges that threaten to derail achieving 2023-24’s fiscal target of 5.9%, such as the high capex growth so far this year and pre-election spending. But surprisingly high direct tax collections and a cut in capex for the rest of the year could help. Alongside this, the spending quality by states has improved markedly this year.

Sounds good, so what’s the problem?

India’s GDP growth has been robust. It is forecast by the Reserve Bank of India (RBI) to be 6.5% for the current year, which is exactly where it was in the last ‘normal’ year before the pandemic (i.e. 2018-19). This begs the question that if GDP growth is back at pre-pandemic levels, why is the central government fiscal deficit much higher (5.9% target for 2023-24 versus 3.4%)?