The challenge of achieving fiscal consolidation and fiscal stimulus at the same time

24 Jan 2023 , 05:03 PM

The important challenge before the government in Budget FY 24 is how to keep fiscal deficit in control while also providing enough stimulus to accelerate growth in the economy. Fiscal deficit target of the government for FY 24 is likely to be between 5.6% – 5.9% of GDP. In FY 23, this target was 6.4% of GDP. The government is expected to achieve its fiscal deficit target for FY 23.

2023 is the last year before general elections. Globally there is a severe economic slowdown. This economic slowdown is all set to worsen this year. The Government therefore cannot afford to reduce its expenditure in order to control fiscal deficit. It is unlikely that subsidies on fertilizer, food etc. will be cut down significantly in the year before the election year. Fertilizer subsidy bill can come down simply because of decline in fertilizer prices. This decline is expected to happen because of the expected decline in prices of key raw materials such as natural gas, that are used in fertilizers. 

 Pradhan Mantri Garib Kalyan Ann Yojna (PMGKAY) was discontinued recently. But the savings made from this discontinuation will be offset by the announcement that the poor will now get 5 kg of grains per month per person, free of cost, under National Food Security Act. 

The government is likely to accelerate the pace of its capital expenditure in FY 24 budget. Some of the capital expenditure is likely to go towards the rural parts of the country. These parts have been severely hit by the reverse migration caused by Covid lockdowns.  Due to the reverse migration caused by Covid lockdowns, domestic remittances have gone down. Domestic remittances are the money that workers from rural areas working in Indian cities send back to their homes in villages. 

Governments increase their expenditures during times of economic slowdown. This is done to increase demand in the economy. Aggregate demand in the economy is made up of four components. These are Government Expenditure, Consumption, Investment and Net Exports. So if Government expenditure goes up, aggregate demand in the economy also goes up. Increase in aggregate demand gives a boost to economic growth. 

In such a scenario, a path that the government can take is to provide highly targeted fiscal stimulus to sectors and areas that strongly need such a stimulus.  Incentives that have been given to sectors that are performing well can be temporarily withdrawn. Limiting fiscal stimulus to sectors that have been worst hit by the Covid crisis and the ongoing economic scenario will achieve the objective of giving fiscal stimulus while not letting fiscal deficit to increase too much. 

In an economy that is in a slowdown, the government cannot afford to increase tax rates for raising its revenues. Such a move will also be politically unpopular. The middle class is expecting that the government will increase the income threshold for personal income taxes. A large section of this middle class is an important vote bank of the government. 

In the area of fiscal prudence, the track record of the current government is a good one. During the two years of Covid lockdowns and restrictions, Indian government provided much less fiscal support than other countries, in order to keep fiscal situation sound. Whether the government chooses to maintain this fiscal record or not will be revealed on the Budget Day.