Skip to main content

Fiscal Policy in India

Fiscal policy is a critical tool for the Indian government to manage the economy. It involves the use of government spending, taxation, and borrowing to influence economic growth, control inflation, reduce unemployment, and achieve a sustainable fiscal deficit. This document provides an overview of India's fiscal policy, its objectives, components, recent trends, and challenges.

Understanding Fiscal Policy​

Definition​

  • Fiscal Policy refers to the government's use of taxation, public spending, and borrowing to influence the economy.
  • The policy is primarily managed by the Ministry of Finance and involves measures to control government revenue (taxation) and expenditure to achieve macroeconomic stability.

Objectives of Fiscal Policy​

  1. Economic Growth: To promote sustainable economic growth by providing public goods and services, investing in infrastructure, and supporting key sectors.
  2. Price Stability: To control inflation through prudent fiscal management, including adjustments in tax rates and public expenditure.
  3. Employment Generation: To reduce unemployment by creating job opportunities through government spending on public works and development projects.
  4. Redistribution of Income: To reduce inequality by imposing progressive taxes and implementing welfare programs for the poor and marginalized sections of society.
  5. Fiscal Discipline: To maintain a sustainable fiscal deficit and debt level, ensuring long-term economic stability.

Components of Fiscal Policy​

1. Government Expenditure​

  • Capital Expenditure: Spending on long-term investments such as infrastructure, roads, bridges, schools, and hospitals. It enhances the productive capacity of the economy.
  • Revenue Expenditure: Spending on day-to-day functioning of the government, such as salaries, pensions, subsidies, and interest payments. It does not create any asset or reduce any liability.
  • Subsidies: Financial support provided by the government to make essential goods and services affordable, especially to lower-income groups. Major subsidies in India include those for food, fertilizers, and fuel.

2. Government Revenue​

  • Tax Revenue: Revenue collected through direct taxes (income tax, corporate tax) and indirect taxes (GST, customs, excise).
    • Direct Taxes: Taxes directly levied on individuals and corporations, such as income tax, corporate tax, and wealth tax.
    • Indirect Taxes: Taxes levied on goods and services, such as the Goods and Services Tax (GST), customs duty, and excise duty.
  • Non-Tax Revenue: Revenue earned from sources other than taxes, such as dividends from public sector enterprises, interest receipts, and fees.

3. Fiscal Deficit​

  • Fiscal Deficit is the difference between the total government expenditure and total revenue (excluding borrowing).
    • A fiscal deficit indicates the extent of government borrowing needed to meet its expenditure requirements.

4. Public Debt​

  • Public Debt refers to the total borrowings of the government. It includes both internal debt (borrowings from within the country) and external debt (borrowings from foreign sources).
    • Public debt is used to finance the fiscal deficit and manage temporary liquidity shortfalls.

1. Fiscal Consolidation​

  • The Indian government has aimed for fiscal consolidation by reducing the fiscal deficit to a sustainable level. The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was enacted to institutionalize fiscal discipline and reduce India's fiscal deficit.
  • According to the Union Budget 2023-24, the government aims to reduce the fiscal deficit to 5.9% of GDP by the end of 2023-24 and further to 4.5% of GDP by 2025-26.

2. Tax Reforms​

  • Goods and Services Tax (GST) (2017): A significant indirect tax reform that subsumed multiple taxes, creating a unified tax structure and improving compliance and revenue collection.
  • Corporate Tax Rate Reduction (2019): The government reduced the corporate tax rate to 22% (for domestic companies) and 15% (for new manufacturing companies) to boost investment and economic growth.

3. Increase in Capital Expenditure​

  • In recent years, there has been a significant increase in capital expenditure, particularly on infrastructure projects like roads, railways, ports, and rural development, to boost economic growth and create employment opportunities.
  • The Union Budget 2023-24 allocated ₹10 lakh crore for capital expenditure, a 33% increase from the previous year.

4. Focus on Social Welfare​

  • Increased spending on social welfare schemes, such as PM Garib Kalyan Yojana, PM Awas Yojana, and Ayushman Bharat, to provide direct benefits to the poor and vulnerable sections of society.
  • Enhanced allocation for education, health, rural development, and agriculture to promote inclusive growth.

5. Borrowing and Public Debt Management​

  • The government has relied on both internal and external borrowings to finance its fiscal deficit, with an increased focus on sustainable debt management to avoid a debt trap.
  • In the Union Budget 2023-24, the government's gross borrowing is estimated at ₹15.43 lakh crore.

Challenges in Fiscal Policy​

  1. High Fiscal Deficit and Public Debt

    • Despite efforts to reduce the fiscal deficit, it remains relatively high, limiting the government's ability to spend on development programs. High public debt also increases interest payments, reducing the fiscal space for productive expenditure.

  2. Tax Compliance and Collection

    • Tax evasion and low compliance rates pose challenges to revenue collection. Although GST has improved indirect tax compliance, direct tax collection remains a challenge.

  3. Subsidy Burden

    • The government spends a significant amount on subsidies, such as food, fertilizer, and fuel, which puts pressure on the fiscal deficit. Rationalizing subsidies without impacting the poor remains a challenge.

  4. Economic Slowdown

    • Slower economic growth affects tax revenues and increases the fiscal deficit, making it harder to achieve fiscal consolidation targets.

  5. Expenditure Efficiency

    • Inefficient public expenditure, leakages in welfare schemes, and corruption reduce the effectiveness of fiscal policy. Improving the quality and efficiency of public spending is crucial.

  6. Global Uncertainties

    • External factors, such as global economic conditions, oil prices, and geopolitical tensions, impact fiscal policy. For example, high global oil prices can increase India's import bill, affecting the fiscal deficit.

Government Initiatives for Fiscal Management​

1. Fiscal Responsibility and Budget Management (FRBM) Act, 2003​

  • The FRBM Act mandates the government to ensure fiscal discipline by setting targets for fiscal deficit and public debt. It also requires regular monitoring and reporting to ensure transparency.

2. Goods and Services Tax (GST)​

  • The implementation of GST aimed to create a unified tax structure, improve tax compliance, reduce tax evasion, and increase revenue collection, thus contributing to fiscal consolidation.

3. Direct Benefit Transfer (DBT)​

  • DBT is designed to reduce leakages in subsidy distribution and improve the efficiency of welfare schemes. It ensures that subsidies reach the intended beneficiaries directly, reducing the burden on the fiscal deficit.

4. Disinvestment of Public Sector Undertakings (PSUs)​

  • The government has focused on disinvestment and privatization of PSUs to generate revenue, reduce the fiscal deficit, and improve the efficiency of public enterprises.

5. National Infrastructure Pipeline (NIP)​

  • Launched in 2019, the NIP aims to invest ₹111 lakh crore in infrastructure development over five years, promoting growth and job creation. Increased capital expenditure on infrastructure is expected to have a multiplier effect on the economy.

Conclusion​

Fiscal policy is a crucial instrument for achieving India's macroeconomic goals, including economic growth, price stability, employment generation, and equitable income distribution. However, challenges such as high fiscal deficits, subsidy burdens, tax compliance issues, and global uncertainties must be managed effectively. Ongoing reforms and prudent fiscal management are essential for ensuring sustainable growth and stability.

Key Terms: Fiscal Deficit, Public Debt, FRBM Act, Goods and Services Tax (GST), Direct Benefit Transfer (DBT), Capital Expenditure, Revenue Expenditure.

Further Reading: