Fiscal consolidation is a set of policies undertaken by the government so as to reduce government deficits and debt accumulation. They are measured as a per cent of nominal GDP. Deficits can be curbed by better economic growth leading to more revenues and less expenditure. In this article, we will study about fiscal consolidation which is important for the UPSC examination.

What is Fiscal Consolidation?

• Various policies undertaken by the government at national as well as sub-national levels to reduce the accumulation of debts and reduce deficits is known as fiscal consolidation.
• Fiscal consolidation can be achieved by increasing revenue and decreasing expenditure.
• The fiscal deficit is the most important indicator of the government's financial health. The fiscal deficit, on the other hand, represents the amount of government borrowing for that given year.
• The Government's two major deficits are the Revenue Deficit and the Fiscal Deficit.
• The following are some of the negative consequences of a budgetary deficit.
  • Interest rates rise as a result.
  • It raises the rate of inflation.
  • The government's burden of increasing interest payments grows.

Evolution of Fiscal Consolidation Policy in India

• The concept of Medium-Term Fiscal Reform Programmes (MTFRPs) was introduced in 2000–01 by the Ministry of Finance.
• It was focused on reducing wasteful expenditure and improving the better management of the tax administration.
• MTFRPs could not achieve the required target and the fiscal situation deteriorated.
• The Eleventh Finance Commission (EFC) 2000 created a Fiscal Reform Facility (FRF) for fiscal adjustment.
• It was based on the release of a 15 percent grant to states by linking it with improved fiscal performance.
• The Twelfth Finance Commission (TWFC) laid down a debt write-off scheme for better fiscal governance by the states and also that each state enacts a fiscal responsibility law to reduce revenue and fiscal deficit.
• The Thirteenth Finance Commission recommended that two debt relief measures should be applicable to all the states such as
  • The interest rate on loans from the National Small Savings Fund (NSSF) to states should be reset at 9 percent.
  • Writing-off central loans to states.
• However, macroeconomics led to an urgent need for imposing statutory ceilings on the central government’s borrowings, debt, and deficits.
• Hence the Government of India enacted the FRBM (Fiscal Responsibility and Budget Management) Act in 2003.

Fiscal Responsibility and Budget Management (FRBM) Act

• It requires that the center’s fiscal deficit be reduced to 3 percent of GDP and the revenue deficit be reduced by an amount equivalent to 0.5 percent or more of GDP at the end of each year.
• Similar parameters were accepted by the state governments to reduce fiscal deficit to 3 percent of gross state domestic product (GSDP) and eliminate revenue deficits by 2013–14.
• It mandates that the central government should disclose any specific changes in accounting standards, policies, and practices to ensure transparency in operations.
• The statements on medium-term fiscal policy, the macroeconomic framework, and the fiscal policy strategy should be presented by the government in each financial year.
• This act also consists of an exclusion clause which states that the government may deviate from prespecified fiscal targets if there are certain unforeseeable circumstances such as internal disturbances or a natural calamity.

Fiscal Consolidation - Tools

• The term 'fiscal' is short for 'budget,' and it refers to the government's budget. As a result, fiscal policy is the use of government spending, taxes, and transfers to impact aggregate demand and, as a result, real GDP.
• Below is a brief description of the three fiscal policy tools.
  • Government Spending: Government spending can have an impact on economic output. Government expenditure can be classed as Government Final Consumption Expenditure since it comprises the acquisition of goods and services for the benefit of the community.
    • Government Gross capital creation is defined as government spending on research and infrastructure with the goal of generating future benefits.
    • The government should reduce its spending on infrastructure and use its resources efficiently to follow fiscal consolidation.
  • Transfer Payments: Government payments to individuals through social welfare programs, student subsidies, and Social Security are referred to as transfer payments.
    • The spending on transfer payments and welfare is reduced while taking up fiscal consolidation.
  • Taxes: Changes in taxes affect the typical consumer's income, and changes in consumption lead to changes in real GDP. As a result, the government can impact economic output by altering taxation. Taxes can be altered in a variety of ways.
    • The government has to set tax rates keeping in mind the maximization of revenue in terms of tax revenue.

Recommendations of 15th Finance Commission Regarding Fiscal Consolidation

• The Union government should reduce its fiscal deficit to 4% of its Gross Domestic Product by 2025-26 against 6.8% in FY22.
• The fiscal deficit of state governments should be at 4% of Gross State Domestic Product in 2021-22, 3.5% in the following year, and 3% for the next three years.
• Borrowing limits for state governments should be fixed at 4% of Gross State Domestic Product in 2021-22, 3.5% in 2022-23, and at 3% of GSDP from 2023-24 to 2025-26.
• The suggested fiscal consolidation path is as follows:

• If the states fulfil the parameters for power sector reforms then additional borrowing of 0.5% of GSDP should be allowed.
• It mandates third-party evaluation of all centrally sponsored schemes within a fixed time period.
• Restructuring of FRBM act.

Conclusion

Various reforms have been undertaken to improve fiscal responsibility but they have proved to be inadequate. The fiscal situation deteriorates as revenue expenditure exceeded revenue receipt. Hence it is essential that the fiscal consolidation arrangement should focus on capital expenditure, one of the essential growth indicators which need to be increased.