The Fiscal Responsibility and Budget Management Act mandates that India’s fiscal deficit be limited to 3 percent of GDP. While the rule was introduced to maintain financial stability, it has unintentionally restricted growth-oriented spending. It has led to a greater focus on revenue expenditure (like salaries, subsidies and interest payments) rather than capital expenditure (like roads, railways and healthcare), which are essential for long-term development. As India aims to become a developed nation by 2047, it’s time to rethink this approach.
Economic research suggests that a rigid 3 percent deficit limit does not always benefit growth. The government should have the flexibility to increase the deficit during slowdowns and scale it down when growth is strong. The current policy forces states and the central government to prioritise short-term expenses over long-term assets, which slows down overall development.
Indian states are particularly struggling due to limited fiscal space, affecting their ability to invest in public infrastructure, healthcare and education. Since most states rely on central funds, a one-size-fits-all deficit rule fails to consider the regional economic differences and financial constraints.
Developed nations often follow flexible deficit policies. The US maintains an average fiscal deficit of 5-6 percent, with 2.3 percent of GDP allocated to infrastructure and 3.1 percent to research and development. Germany follows a strict fiscal discipline model; but during economic crises, it relaxes the limit to allow for higher investments. Japan, despite its 200 percent debt-to-GDP ratio, invests heavily in technology and public services, ensuring long-term benefits. Australia operates a flexible strategy and funds infrastructure through public-private partnerships to minimise financial strain on the government.
Many Indian states exceed the prescribed 3 percent limit due to revenue shortfalls, forcing them to rely on market borrowings, which further increases their debt burden. As of 2023, the combined fiscal deficit of Indian states stood at 4.1 percent of GDP. States like Punjab and Kerala have debt-to-GSDP ratios exceeding 40 percent, raising concerns about fiscal sustainability. Kerala and Tamil Nadu, which have robust welfare programmes, often find themselves constrained, while high-growth states like Maharashtra and Gujarat require greater flexibility to fund infrastructure expansion. Given that states are responsible for nearly 60 percent of total public expenditure, revising the policy to accommodate state-specific growth needs is crucial.
To ensure better planning, India needs to shift towards zero-based budgeting (ZBB). Unlike traditional budgeting, where past expenditures dictate future allocations, ZBB requires the government to justify every rupee spent from scratch. This approach would help eliminate wasteful expenditure, prioritise high-impact projects and improve accountability.
India should also explore innovative ways to finance deficits without increasing the debt burden. Encouraging private sector investments in infrastructure and public services through more partnerships can reduce the fiscal burden while ensuring better efficiency in project execution. India currently ranks 63rd in the World Bank’s Ease of Doing Business Index, indicating a large room for improvement.
Norway and Singapore successfully use sovereign wealth funds to fund long-term development. India could allocate part of its $615-billion foreign exchange reserves to such a fund to finance infrastructure and technology projects. Allowing financially strong states to borrow more for productive investments while keeping strict oversight on weaker states would create a balanced and sustainable fiscal approach.
The government can lease or sell underused assets such as land, buildings and infrastructure to raise funds without increasing debt. The National Monetisation Pipeline aims to generate `6 lakh crore by leasing assets over 4 years. A more efficient and transparent GST framework can enhance state revenues, reducing the need for excessive borrowing.
A critical aspect of fiscal policymaking is the accuracy of economic indicators. Former Chief Economic Adviser Arvind Subramanian has argued that India’s GDP has been overestimated in recent years, with actual growth rates likely 2.5 percentage points lower than that officially reported. If true, this overestimation significantly affects fiscal calculations, as GDP projections determine deficit ratios. An inflated GDP masks the real fiscal stress, leading to misguided policy decisions and underestimation of risks. This discrepancy can lead to higher borrowings, with policymakers assuming a stronger repayment capacity than what truly exists.
Fiscal deficit targets should vary in the 3.5-4.5 percent range based on growth and capital investment needs. The focus should shift from revenue expenditure to infrastructure, healthcare and education. ZBB should be implemented to reassess spending priorities each year. Greater accountability in government spending can be ensured by involving independent audits and public scrutiny.
Instead of blindly following a rigid rule, fiscal policies must be tailored to the needs and regional potential. Only then can India strike the right balance between economic stability and rapid development.
(Views are personal)
P K Santhosh Kumar | Director, Centre for Budget Studies, Cochin University of Science and Technology