The Need for Fiscal Consolidation in India

This topic of “The Need for Fiscal Consolidation in India” is important from the perspective of the UPSC IAS Examination, which falls under General Studies Portion.

What the editorial is about?

The basic determinants of economic growth for 2022-2023 and the need for Fiscal Consolidation in India.

Context:

• The first advance national accounts estimate for 2021-22 is released by the National Statistical Office (NSO) recently.
• India’s real GDP growth in 2021-22 is estimated at a 30 basis point lower than the projection by the Reserve Bank of India and the International Monetary Fund (IMF) projection of 9.5%. i.e., 9.2%.
• The adverse effect of the third wave of COVID-19, which is mainly affecting the last quarter of 2021-22, may call for another downward adjustment in the growth rate to about 9%.

Determinants of Economic Growth for 2022-23 for India

Capacity utilization

• Continues to have considerable slack
• The capacity utilization ratio was only 61.7% in the preceding four quarters of 2021-22.

Private final consumption expenditure (PFCE)

• Shows a low growth of 6.9% in 2021-22.

Gross Fixed capital formation (GFCF)

• As per the advance estimates, the gross fixed capital formation (GFCF) relative to GDP at current prices stands at 29.6% in 2021-22.
• Meeting the GFCF target could be challenging given that private sector investment is still weak due to continued uncertainty over the Covid-19 pandemic.

Fiscal Deficit

• ICRA estimates the GoI’s fiscal deficit at 5.8 per cent of the GDP in FY23.
• Considering the AY 2021-22, The annual growth in the Center’s Gross Tax Revenue may be close to 35%, implying a buoyancy of nearly 2.
• With these buoyant tax revenues, the Government may be able to limit the 2021-22 fiscal deficit to its budgeted level of 6.8% of GDP.

Low-Income Growth

• Any pick-up in demand would continue to be constrained by low-income growth in sectors characterized by a high marginal propensity to consume (MPC) such as the trade, transport, and the Micro, Small and Medium Enterprise (MSME) sectors.

Nominal GDP Growth

• Implicit price deflator (IPD)-based inflation was as high as 7.7% in 2021-22.
• The nominal GDP is estimated to be higher by almost 4.2% from the budget estimate for FY22.

Real-GDP growth

• Growth in 2022-23 could continue to be constrained by supply-side bottlenecks and high prices of global crude and primary products. It may thus be prudent to expect real GDP growth in the range of 6-7%.

GST Compensation

• The GST compensation provision would also come to an end in June 2022.
• This would cause a major revenue shock at least for some states such as Kerala, Tamil Nadu and Andhra Pradesh.

Corporate Income Tax (CIT) Reform

• The major corporate income tax (CIT) reform undertaken in 2019-20 had provided a concessional CIT rate of 15% for fresh investment in manufacturing by domestic companies provided their production took off on or before March 31, 2023.

Reasons to Focus on Fiscal Consolidation

• Fiscal consolidation is a process in which the government’s fiscal health improves, as evidenced by a smaller fiscal deficit.
• As the fiscal deficit falls below a tolerable level, improved tax revenue realization and better-directed expenditure are key components of fiscal consolidation.
• In India, the fiscal deficit is the most important indicator of the government’s financial health.
• The Fiscal Responsibility and Budget Management (FRBM) Act gives the targets for fiscal consolidation in India.
• It would be appropriate in current economic conditions to consider a graduated return to fiscal consolidation while using fiscal policy to lay the base for faster growth in the years to come.

As suggested by the 15^th Finance Commission

• The Fifteenth Finance Commission had suggested a fiscal consolidation path where the Centre’s fiscal deficit was benchmarked at 5.5% of GDP for 2022-23. It was kept at 6% of GDP in their pessimistic scenario.
• It may be prudent to limit the reduction in fiscal deficit-GDP ratio to about 1% point of GDP in 2022-23. This would imply a fiscal deficit in the range of 5.5%-6% of GDP.
• A stepwise reduction of 0.5% points per year from here onwards would enable a level of about 4% of GDP by 2025-26.
• A high-powered inter-governmental group should be constituted to re-examine the sustainability parameters of debt and fiscal deficit of the central and state governments by this time.

Other Suggestions to Achieve Fiscal Consolidation

Extension of GST compensation period

• Considering its impact on the Center’s Budget, the GST compensation arrangement should be extended by two years in some modified form.

Disinvestment initiatives

• Disinvestment initiatives may have to be accelerated.

Expenditure prioritization

• Expenditure prioritization in 2022-23 should focus on reviving both
  • Consumption demand
  • Investment demand

An urban counterpart to MGNREGA

• Since consumption demand remains weak, some fiscal support in the form of an urban counterpart to the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) may be considered.

National Monetization Pipeline

• With respect to non-tax receipts, the scope of the National Monetization Pipeline (NMP) may be extended to cover the monetization of government-owned land assets.

National Infrastructure Pipeline (NIP)

• The National Infrastructure Pipeline (NIP) should be reassessed in order to make up for existing deficiencies in relation to the original targets.