The Indian government and the International Monetary Fund have differing perspectives over fiscal consolidation strategies. While the IMF prescribes a strict fiscal diet—capping the Union government’s deficit at 3% of GDP and the combined deficit below 6% — New Delhi insists that such targets are easier suggested than implemented. A structural shift in capital expenditure, with public sector enterprises offloading their spending burdens onto the Union budget. The government has pushed back against rigid fiscal targets, arguing that economic growth could suffer if fiscal policy is overly constrained.
In its latest Article IV consultation report on India, the IMF advised the country to reduce its fiscal deficit in the medium term while simultaneously increasing infrastructure spending by both the Union and state governments. However, Indian authorities countered that this would necessitate eliminating the revenue deficit—an infeasible move in the near term that could compromise economic growth. While external recommendations from the IMF and other institutions provide valuable insights, blindly following them without considering India’s unique economic challenges can be counterproductive. Global pressures sometimes advocate policies that are misaligned with India’s current development stage.
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Fiscal consolidation vs economic development
Fiscal consolidation has been a clear priority for the NDA government in successive budgets, and rightly so, given the ripple effects of fiscal prudence. There are compelling reasons for the government to exercise caution in its spending. First, maintaining fiscal discipline could pave the way for the monetary policy committee to consider interest rate cuts in upcoming meetings. Second, the recent announcement of the Eighth Pay Commission, which is expected to significantly increase government revenue expenditure, will likely compel the Union government to create fiscal space without disrupting its financial stability.
Additionally, India’s growing integration with global bond markets has increased scrutiny from foreign investors. Large fiscal deficits could trigger FPI outflows, leading to higher bond yields and a weaker rupee—risks that are exacerbated by global economic uncertainty. Given these considerations, the Statement of Fiscal Policy accompanying the Budget indicates that the government will continue its cautious approach.
However, critics argue that excessive fiscal restraint may not be advisable when economic activity remains tepid. The debate over prioritising growth over fiscal prudence is growing louder. While fiscal consolidation is essential for financial stability and maintaining investor confidence, it is equally important to acknowledge that India’s post-pandemic economic recovery has been driven by substantial government capital expenditure. If private sector investment remains sluggish, the government cannot afford to derail growth by tightening spending prematurely. Many economists suggest that India should adopt a more gradual approach to fiscal consolidation and offer relief to boost consumer confidence. The rationalisation of income tax slabs in Budget 2025 is a step in that direction.
Revenue mobilisation and fiscal efficiency
The government has emphasised the need for improved revenue mobilisation while supporting voluntary tax compliance. It aims to achieve this through tax law simplification and digitalisation of tax administration. India has already undertaken significant efforts to streamline the Income Tax Act, focusing on revenue optimisation by maximising tax collection, reducing tax evasion, and broadening the tax base.
The IMF also advocates a revenue-based consolidation strategy, urging India to enhance revenue collection through Goods and Services Tax (GST) simplification, tax rate adjustments, and aligning domestic energy prices with global markets. Additionally, it recommends improving fiscal efficiency by refining subsidy targeting, transitioning to direct cash transfers where feasible, and rationalising expenditure schemes to generate savings.
India’s progress in fiscal consolidation
Fiscal deficit is a key indicator of a country’s economic health, reflecting how well a government manages its revenue and expenditure balance. Generally, countries aim to narrow their fiscal deficits as this signals better debt management. Conversely, a rising deficit raises concerns over fiscal sustainability.
India has been on a steady fiscal consolidation path, reducing its fiscal deficit from a pandemic peak of 9.2% of GDP in FY 2020-21 to an estimated 5.6% in FY 2023-24, with a target of 4.9% for FY 2024-25. Through targeted spending and enhanced revenue collection, the country has made notable progress in fiscal consolidation under the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.
Fiscal strategy for FY 2025-26
The upcoming fiscal year 2025-26 presents an interesting scenario as most global economies anticipate a moderation in fiscal deficits. Finance minister Nirmala Sitharaman has set a fiscal deficit target of 4.4% for FY26, aligning with the government’s commitment to reducing the budget gap to below 4.5% by 2025-26. This projection is consistent with an EY report, which forecasts a decline in the general government fiscal deficit relative to GDP in most major economies in 2025 and 2026.
In the recently announced Union Budget, Sitharaman introduced a new fiscal strategy, shifting from a fiscal deficit-based anchor to a debt-to-GDP ratio target. Under a six-year roadmap, India aims to reduce its debt-to-GDP ratio from 57.1% in FY25 to 50% by FY31, with a margin of error of 1%. The FY26 budget projects a reduction to 56.1%, assuming a nominal GDP growth rate of 10.1%, which suggests a planned annual decline of 1%.
Given India’s sluggish growth in recent quarters, the government must accelerate capital expenditure to drive job creation and boost consumption. However, there is growing concern that government-led capital spending may not generate the same multiplier effect it did in previous years. The challenge ahead lies in striking a balance between three critical objectives—fiscal consolidation, employment generation, and economic growth. As the government navigates this complex fiscal landscape, its policy choices will play a decisive role in shaping India’s economic trajectory in the coming years.