Debt Reduction Over Deficit Control For Fiscal Sustainability

Finance Minister Nirmala Sitharaman will present Union Budget 2025-26 this week, marking it her eighth presentation. Traditionally, fiscal consolidation debates have centred around the fiscal deficit as a percentage of GDP, but recent shifts in focus towards the debt-to-GDP ratio reflect a more pragmatic approach. Unlike annual fiscal deficit targets, which often lead to short-term expenditure adjustments, managing the debt ratio ensures long-term fiscal sustainability and economic stability.

India’s fiscal deficit has steadily declined from 9.2% of GDP in 2020-21 to an estimated 4.9% in 2024-25, as per budget projections. However, while fiscal deficit reduction aligns with the Fiscal Responsibility and Budget Management Act’s target of 3%, the broader debt-to-GDP ratio remains a more crucial metric. The central government’s debt-to-GDP ratio, which stood at 61.6% in 2020-21, is projected to decline to 56.8% in 2024-25. 

Economic shocks like the 2008 global financial crisis and the COVID-19 pandemic highlight why prudent debt management is preferable over rigid deficit control. A narrow focus on fiscal deficit reduction often leads to indiscriminate cuts in capital expenditure or essential welfare programmes, undermining long-term growth. In contrast, targeting a sustainable debt ratio allows for more strategic resource allocation. For instance, capital expenditure with a high multiplier effect can initially raise debt but, over time, fosters economic productivity, offsetting the burden.

Economic literature strongly supports this approach. Carmen M. Reinhart and Kenneth S. Rogoff’s (2010) empirical study on government debt found that emerging economies experience median GDP growth of 4.0–4.5% when debt levels remain below 90% of GDP. However, beyond this threshold, growth declines significantly to 2.9%.

Alesina et al. found that expenditure-based debt reduction strategies were less harmful to growth than tax-driven consolidation. Similarly, a National Institute of Public Finance and Policy study by Bose and Bhanumurthy in 2013 highlighted that capital expenditure in India has a multiplier effect of 2.45—significantly higher than tax reductions at 0.98 or revenue expenditure at 0.99. This reinforces why fiscal consolidation should prioritise growth-driven debt management rather than rigid fiscal deficit targets.

The government’s shift towards capital expenditure-driven fiscal consolidation aligns with empirical evidence supporting investment-led growth. However, recent trends in capital expenditure utilisation raise concerns. Data from the Controller General of Accounts dashboard as of November 2024 shows that only 49% of the annual ₹11,100 billion capital expenditure target for 2024-25 has been utilised, marking a 12.3% year-on-year decline. This slowdown is attributed to election-related disruptions, adverse weather conditions, and tighter state borrowing norms. 

Care Edge Ratings highlights weak capital expenditure as a drag on fiscal performance, with major Central Public Sector Enterprises cutting spending by 10.8% in the first half of the financial year. Twenty major states have met just 28% of their capital expenditure targets, though increased disbursements in the final quarter may bridge some of the shortfall.

Meanwhile, revenue expenditure has grown 7.8% year-on-year, driven by higher borrowing costs, subsidy allocations, and welfare spending. Interest payments have risen by 8.3%, further pressuring fiscal sustainability.  For instance, the Centre’s total major subsidy bill stood at ₹2.79 trillion as of November 2024, 73% of the budget estimates, higher than the previous year’s corresponding period. 

Policy Outlook

A critical tool in fiscal assessment is the Output-Outcome Monitoring Framework, introduced in 2019-20. The framework tracks output and outcome indicators for government schemes, offering transparency and accountability. However, its effectiveness hinges on systematic multi-year evaluations rather than single-year snapshots. 

The reporting under the Output-Outcome Monitoring Framework should be practical, ensuring that assessments capture meaningful progress rather than rigid short-term targets. Evaluating the effectiveness of government spending requires a multi-year approach to determine whether the allocated funds have truly delivered results.

For instance, a university designated as an Institute of Eminence may be required to report quarterly on offering interdisciplinary courses in emerging technologies and areas critical to national development during 2023-24. However, universities typically plan and introduce such courses on an academic-year basis, with preparations starting much earlier. Annual targets in such cases fail to provide a meaningful assessment. A more effective approach would be to measure progress over a four- to five-year period, allowing for a comprehensive evaluation of outcomes. A multi-year analysis of Output-Outcome Monitoring Framework data would mitigate distortions caused by delays in fund utilisation, external shocks, or election cycles, offering a clearer and more accurate picture of policy effectiveness. Strengthening this framework is crucial to ensuring fiscal strategies remain focused on long-term stability and sustainable growth rather than short-term reactive measures.

India’s evolving fiscal strategy prioritises debt-to-GDP stability over arbitrary fiscal deficit targets—a move aligned with sustainable economic growth. Ensuring the effective use of public resources demands high-quality expenditure and robust evaluation mechanisms, assessed over extended horizons. As India navigates fiscal challenges, a long-term perspective will be key for stability and growth.