FISCAL CONSOLIDATION (Syllabus: GS Paper 3 – Economy)

Context: Finance minister of India in her Budget speech, has said that from 2026-27 onwards, the endeavour would be to keep the fiscal deficit such that the central government debt is on a declining path as a percentage of GDP.

Fiscal Consolidation 

• About: It refers to a series of government policies aimed at diminishing deficits and restraining the accumulation of debt. These policies are typically assessed as a percentage of nominal GDP.
• Fiscal Deficit: It is the gap between the government's overall income (including taxes and non-debt capital receipts) and its total expenditure.
• Deficit Reduction Strategies: The reduction of deficits can be achieved through enhanced economic growth, resulting in increased revenues and reduced expenditures. Fiscal consolidation involves a dual approach of boosting income and trimming expenses.

Tax-GDP ratio gap for India

• Tax Buoyancy: The responsiveness of taxes to an increase in the GDP is termed as tax buoyancy. Increasing the tax-GDP ratio is crucial for revenue generation and to contain deficits. However, increasing the tax rates does not always result in a rise in tax revenue.
• Importance of Tax Administration: In the context of an emerging economy, ‘tax administration is tax policy.’ Therefore, widening the tax base and strengthening the digital infrastructure in tax administration are crucial for raising tax revenue.
• NK Singh FRBM Panel: NK Singh was the chairman of the FRBM panel which suggested the above-mentioned debt deficit targets. 
• The Singh panel also suggested an “escape clause” in the FRBM Act, on the basis of national security, war, national calamity, etc., and structural reforms in the economy resulting in fiscal implications.

  Importance of Fiscal Consolidation

  • Fiscal Rule: It is a constraint on fiscal policy through numerical limits on deficits.
  • Indian Fiscal Rule under FRBM Act: As per the Fiscal Responsibility and Budget Management (FRBM) Act envisions a fiscal deficit at 3% of GDP.
  • Post-Pandemic Fiscal Strategy: In the post-pandemic fiscal strategy, the fiscal glide path aims to reduce the fiscal deficit to below 4.5% of GDP by 2025-26.
  • General Government Debt Target: Fiscal rules envision general government debt to be 60% of GDP, with a 3:1 ratio between the Centre and the states.
  • Deficit Financing Patterns: The financing pattern of deficits includes three methods: seigniorage financing (monetary financing), internal bond financing, and external financing.
  • Predominant Financing Methods: In India, internal bond financing predominates, while in Sri Lanka, external financing of deficits is more common.