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;