India Needs to Keep Its Deficit Target Flexible. Let’s learn more!

Understanding the Desired Fiscal Deficit

A fiscal deficit occurs when a government's total expenditures, excluding borrowing, exceed its total receipts.

India's Fiscal Responsibility and Budget Management (FRBM) Act, 2003, first set a fixed target for the fiscal deficit in order to preserve budgetary restraint.

Because of shifting macroeconomic conditions and economic shocks, policymakers are now taking into account a more flexible approach known as the Flexible Deficit Target.It makes it possible to adjust fiscal deficit targets in response to economic cycles, external shocks, and investment priorities.

Crucial Components of Flexibility

Countercy clicality is the practice of permitting higher deficits during recessions and retrenchments during periods of rapid economic growth.

Expenditure prioritization is the process of lowering non-essential spending while increasing spending on essentials like infrastructure and welfare.

Modifying objectives in light of disinvestment earnings, the efficiency of tax collection, and other financial inflows are examples of revenue considerations.

Clauses of Escape: Integrated mechanisms to deviate from deficit targets during emergencies (e.g., pandemic, global shocks).

The creation of the Flexible Deficit Targeting (FRBM) Act in India and its amendments:Reducing the fiscal deficit to 3% of GDP was mandated by the FRBM Act of 2003.

A more flexible approach with a target of 2.5% to 3% and a contingency that allows a 0.5% deviation in exceptional circumstances was proposed by the FRBM Review Committee (N.K. Singh Panel, 2017).

COVID-19's effects (2020–21): The government increased the target budget deficit to 9.5% of GDP in order to demonstrate the necessity of fiscal management flexibility.

Union Budget for 2021–2022 & Beyond: The government set a medium-term goal to lower the deficit to 4.5% of GDP by FY2025-26, rather than imposing a quick return to pre-pandemic levels.

Infrastructure and Social Sector Needs: Developing countries like India must continue to make investments in their infrastructure, health care, and education.A strict deficit target may necessitate spending cuts in these important areas.

Private Sector Confidence: A well-rounded approach that upholds fiscal restraint without being unduly stringent can boost investor confidence.It is essential to ensure that budgetary expansion is targeted and efficient.

The Challenges of Flexible Deficit Targeting

Risk of Fiscal Indiscipline: Without strict targets, borrowing could spiral out of control, increasing debt-to-GDP ratios and the likelihood of credit rating downgrades.Markets and credit rating agencies prefer clearly defined deficit targets for policy certainty.

Market Perception & Investor Confidence: Foreign investors like financial predictability. Policy uncertainty caused by frequent changes to deficit targets may have an effect on bond markets and FDI flows.

Inflationary Pressure: Higher government borrowing may make inflation worse when supply-side constraints are in place.

Increased Interest Costs: Long-term, significant deficits result in higher government debt and interest payments, which lowers the amount of funds available for development projects.

Welfare Program Restrictions: Despite having extensive welfare programs, states like Kerala and Tamil Nadu struggle to expand services like healthcare and education.

Balance between Adaptability and Accountability

Strengthening Fiscal Rules: Set a clear range-based deficit target (e.g., 2.5% – 4% of GDP) rather than imposing a strict fixed one.

One example of institutional oversight is the creation of an independent Fiscal Council to ensure appropriate deficit deviations.

The term "gradual deficit reduction" refers to following a workable glide path toward fiscal consolidation without implementing abrupt spending cuts.

India's shift to a flexible deficit target reflects the need for adaptable economic strategies in an unpredictable world. In order to maintain long-term financial viability, flexibility must be used carefully, even though it promotes growth and helps with crisis management. A balanced approach that maintains a clear medium-term budgetary roadmap while allowing for short-term deviations is necessary to guarantee both economic stability and development.