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Informist, Thursday, Feb. 27, 2025

 

NEW DELHI – India needs to continue with fiscal consolidation over the medium term, at a faster pace if possible, to rebuild fiscal buffers and reduce the debt servicing burden as interest payments absorb around 30% of general government tax revenue, thereby limiting the space to direct revenues towards priority spending, the International Monetary Fund said in a report.

 

The government has announced a shift in its fiscal strategy, targeting debt-to-GDP ratio and keeping the deficit at a corresponding level. In the Union Budget for 2025-26 (Apr-Mar), the government pegged the fiscal deficit at 4.4% of GDP next year, and announced its aim to lower its debt-to-GDP ratio to 50% by March 2031, with a band of 100 basis points on either side. IMF's staff said in the report that a "decline to 50% of GDP can be achieved under current policies, given a favourable interest-growth differential."

 

Responding to the IMF's suggestion, Indian authorities said that targeting a more gradual pace of adjustment – as adopted in the Budget – would be appropriate, given global uncertainties. "Fiscal risks include unanticipated roadblocks in moderating recurrent spending, higher commodity prices, and the realisation of contingent liabilities," the IMF listed. "That said, India has some fiscal space which can be used to support domestic demand and shelter vulnerable households in case of shocks," it added in its Country Report titled India: 2024 Article IV Consultation. 

 

"Placing debt on a firmly downward trajectory is a suitable medium-term anchor, but the medium-term adjustment path should be defined more clearly," the IMF noted. As per the government's statements of Fiscal Policy as required under the Fiscal Responsibility and Budget Management Act, 2003, the Centre's debt-to-GDP ratio in FY26 is seen falling to 56.1% from 57.1% in FY25.

 

The multilateral body said that while the government's intention to target central government debt-to GDP ratios beyond FY26 "is welcome", it can be improved by specific refinements, such as expanding the perimeter to include state government debt and complementing the debt anchor with a fiscal deficit path for the centre and states to provide operational guidance for their respective annual budgets.

 

This comes at a time when few state governments have slipped on fiscal discipline on the back of extravagant welfare spending. State budgets are crucial as the country's fiscal management, particularly from a rating perspective, depends on how effectively the government manages its resources and spending. The government has been advocating that India, currently rated at Baa3 by Moody's--the lowest tier of investment grade--deserves a higher rating because of its economic resilience and stable fundamentals. However, the rating agency, in its Asia-Pacific 2025 Outlook, said India needs to improve drastically on two key metrics--the size of its debt burden and the affordability of its debt - for a sovereign rating upgrade.

 

The IMF projected India's public debt - Centre and states combined - to be at 73.9% in 2033. 

 

According to the IMF, more than half of states, comprising over 60% of the combined gross state domestic product, have primary deficits wider than their respective debt-stabilising primary balance. "This, coupled with high debt and low growth, points to vulnerabilities at the sub-national level. Given their heterogeneity, states require differentiated deficit paths that support fiscal sustainability and economic development, guided by state-level debt sustainability assessments."

 

To build on its fiscal consolidation at a faster pace, the IMF suggested that India adopt a revenue-based consolidation strategy focused on growth-enhancing expenditure, which is appropriate, given India's development needs and revenue potential. "Additional revenue can be raised through GST simplification, partially undoing the past decline in the effective GST rate, reversing fuel excise cuts, broadening the income tax base, and allowing domestic energy prices to move in line with global energy prices," it said. 

 

Interestingly, the IMF suggested that "better targeting of subsidies and replacing them with cash transfers, where possible, would create fiscal savings while still supporting the vulnerable. Similarly, rationalising the volume of expenditure schemes introduced in past budgets would generate cost savings."

 

The multilateral body also suggested that India should raise growth-friendly spending. Improved revenues and containing current expenditure would not only allow for faster debt reduction but would also create room to boost further infrastructure investment, research and development spending to raise private investment and investment in human capital through additional health expenditure, it said. "Returns from infrastructure investment, in terms of quality and access, can be enhanced by refining public investment management."

 

The current government has been pushing capital expenditure to drive growth in the economy in the post-pandemic years. The IMF noted that the use of "windfall gains such as high RBI dividends to finance permanently higher recurrent expenditure should be avoided" and that "states should refrain from expanding recurrent expenditure at the expense of capital expenditure."

 

Despite a huge thrust on capital expenditure in recent years, the Centre's interest payments are set to make up 32.4% of its revenue receipts in FY26, up from 29.0% in FY19. The report said that as per the government's existing policies, the Centre's fiscal deficit will likely reduce to 3.8% of GDP by FY31 and should it adopt the reform measures suggested by the IMF, the fiscal gap could reduce by another 50 basis points in the corresponding period.  End

 

Reported by Priyasmita Dutta

Edited by Deepshikha Bhardwaj

 

 

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