It’s in Our Common Interest

Context: India needs new fiscal rules targeting the interest-revenue ratio.

Evolution of Fiscal Responsibility Budget Management Targets:

• Before the Great Recession: Reducing the fiscal deficit (FD) to 3% of GDP by 2008
• After the Great Recession: an FRBM Review Committee proposed a new target, reducing the ratio of debt (Centre and states) to GDP from almost 70% in 2017 to 60% by 2023.
  • Targeted decline in FD to 2.5% of GDP and revenue deficit to 0.8% by 2023.
• Covid Impact: debt-GDP ratio to 88%. FD ballooned to 9.5% in 2020-21, abandoned the Review Committee’s fiscal target of 2.5%, and now aims for 4.5% by 2025-26. 

Arguments favouring the abandonment of FRBM targets: or their relaxation.

• Global examples: The US, Europe and Japan have abandoned traditional fiscal norms in the face of Covid-19, with FDs of 20% of GDP or more.
  • The Maastricht Treaty of 1993 set a stern FD limit of 3% of GDP for all European members but has been broken by all.

• Low demand: because of demographic trends, lower productivity and new technology that is less capital-intensive, the world now suffers from ‘secular stagnation’ and a chronic savings glut.
  • So printing money no longer stokes demand and inflation, and thus governments should borrow to invest in infrastructure, yielding enough returns in the long run to repay the debt.
• Low cost of debt servicing: When interest rates are low and even negative in some countries, the cost of debt servicing has plummeted. (e.g. Japan  and the US)

Way forward

• New fiscal targets based on Primary Deficit (PD): India’s average primary deficit (FD minus interest payments) has been 3.2%, making its debt/ GDP ratio exceptionally high and unsustainable
  • Should target on reducing PD to zero over time rather than having three targets for debt/ GDP, FD and RD.
  • Implication: Achieving zero PD will provide sustainability in an era of lower interest rates; a country has no need to borrow for paying interest on old debts.

• Create a Primary Surplus: To prevent revenue from going in servicing the old debts.
• Set a target for reducing the interest-to-receipts ratio:  to 33% (means the interest on old debts should not exceed one-third of revenue); will imply lower FDs and a primary surplus;