Subhash Garg Writes: Government Signalling a Shift in Fiscal Deficit Anchor

The Fiscal Responsibility and Budget Management (FRBM) Act mandates the government to ensure the fiscal deficit does not exceed 3% of GDP in any year after 2020–21. The fiscal deficit that year was a humongous 9.2% of GDP.

In the Budget speech for 2021–22, Finance Minister Nirmala Sitharaman assured that the fiscal deficit-to-GDP ratio would be brought down to 4.5% of GDP by 2025–26.

In her Budget speech for 2024–25, the finance minister visited the subject of the fiscal consolidation path and indicated that the government’s endeavour would be to keep the fiscal deficit from 2026–27 at such levels that the central government debt would be “on a declining path as percentage of GDP”.

This was a tricky policy formulation. The government seemed to be signalling that it would no longer adopt the 3% of GDP fiscal deficit goal and shift the deficit financing anchor from the fiscal deficit-to-GDP ratio to the debt-to-GDP ratio.

Budget 2025–26 has two standout features: first, a Rs 1 lakh crore income tax bonanza for 1 crore middle-class taxpayers which will hollow out the taxpayer base.

And second, relegation of capital expenditure to sidelines by reducing the capital expenditure from Rs 11.11 lakh crore in the 2024–25 Budget estimate to Rs 10.18 lakh crore in the 2024–25 revised estimate, keeping only a modestly higher Budget of Rs 11.21 lakh crore for the 2025–26 Budget estimate.

In addition, from the long-term fiscal sustainability viewpoint, the scenarios presented by the finance minister to complete the unfinished business of fiscal consolidation through the debt management route is the third most important feature of Budget 2025–26.

Path to Consolidation

The government has revised the fiscal deficit to Rs 15.69 lakh crore for 2024–25, which is 4.4% of the estimated GDP of Rs 324.11 lakh crore. In the annex ‘Path for Fiscal Consolidation-FY 2026–27 to FY 2030–31 to the Statement of Fiscal Policy under the FRBM Act, 2003, the government [has] laid out the path forward for consolidating fiscal deficit.

It reads, “Sans any major macroeconomic disruptive exogenous shock(s), and while keeping in mind potential growth trends and emergent development needs, the government would endeavour to keep fiscal deficit in each year (from FY 2026–27 till FY 2030–31) such that the central government debt is on declining path to attain a debt-to-GDP level of about 50-plus or minus 1% by 31 March, 2031 (the last year of the 16th Finance Commission cycle).”

In the graphs presented further in the annex, the government assumes three growth scenarios—10%, 10.5% and 11% nominal growth. Further, the government assumes three cases—mild, moderate and hard, to state that under the nominal growth 10% scenario, the debt-to-GDP ratio will decline from 57.1% in 2024–25 to 52% (mild), 50.6% (moderate) and 49.3% (hard). Similar estimations have been made for the two remaining assumed GDP growth rates.

Assume a Scenario

Let us assume the government chooses 10% annual GDP growth and decides aiming at a debt-to-GDP ratio of 50% in 2030–31. Further, it also decides to linearly bring down the debt-to-GDP ratio of 57.1% in 2024–25 to 50% in 2030–21 in six yearly equal reductions of 1.18% every year.

In such a case, the nominal GDP of Rs 324.11 lakh crore in 2024–25 will reach Rs 574.18 lakh crore in 2030–31. With a debt-to-GDP ratio of 50%, the debt would be Rs 287.09 lakh crore that year.

The fiscal deficit-to-GDP ratio in 2030–31 will be 3.47% in such a scenario and not 3%.

In the 10.5% and 11% nominal growth scenarios as well, the fiscal deficit-to-GDP ratio, under the assumption of 50% targeted debt in 2030–31 and evenly phased-out reduction, works out to 3.68% and 3.89% of a GDP of Rs 590.02 lakh crore and Rs 606.22 lakh crore respectively.

Unless the government follows a more aggressive debt-reduction path by frontloading debt reduction in earlier years or going for a more aggressive debt-to-GDP target than 50%, it cannot get to 3% fiscal deficit-to-GDP ratio in 2030–31.

Impossible Assumptions

This formulation of linking fiscal deficit reduction to 3% of GDP even by 2030–31 is based on so many assumptions and uncertainties that is actually a road to nowhere for many reasons.

First, it will have to decide what nominal GDP growth to assume for a long period of seven years. Can the government do so? All three stated scenarios (10%, 10.5% or 11%) for seven years are as uncertain as they can get.

Second, will the government assume a straight-line scenario or some mishmash scenario—10% for one or more years, 10.5% for others and 11% for still others? There is no rational basis to make any of these assumptions.

Third, how will the government decide the goal of the debt trajectory from 57.1% in 2024–25 to 49–51% in 2030–31? Fourth, what are hard, moderate and mild cases? How much more or less than 1.18% of GDP is equivalent debt adjustment?

And fifth, components of government debt are woolly like other liabilities arising from public accounts while others are autonomous. Can the government really make any firm estimates about them?

It seems that this new path has been chosen to avoid making any decision about the fiscal consolidation trajectory to 3% of GDP both in terms of the terminal year of the goal and the fiscal deficit reduction trajectory.

The path of debt-to-GDP ratio sought to be captured in three scenarios with multiple assumptions is the path to nowhere as far as fiscal deficit is concerned.

The writer is former secretary of finance and economic affairs and ex-executive director of World Bank