Business Standard

Recalibrat­ing spend

RBI paper redefines the capex-revenue debate


The government’s commitment to rein in the fiscal deficit and limit borrowing from abroad was re-emphasised in the Interim Budget earlier this month. A gross fiscal deficit of 5.1 per cent of gross domestic product (GDP) has been budgeted for in FY25, reflecting a consolidat­ion of 71 basis points over FY24 (Revised Estimate). The tax-gdp ratio has also increased from 10.1 per cent in FY14 to 11.7 per cent in FY25 (Budget Estimate), along with improvemen­ts in tax-revenue buoyancy. At the same time, restrained growth in revenue expenditur­e, coupled with the impetus provided to capital expenditur­e, signifies that a greater share of the borrowing is now directed towards financing capex. Notably, the secular decline in the ratio of revenue expenditur­e to capital outlay indicates the government’s efforts to improve the quality of expenditur­e, while remaining on the path of fiscal consolidat­ion.

In this context, a recent research article published by the Reserve Bank of India does well to examine the linkages between economic growth and fiscal consolidat­ion in the country. Interestin­gly, the paper redefines capex and looks at developmen­tal expenditur­e (DE) instead — it is broader in scope as it includes social and economic expenditur­e, covering allocation­s for health, education, skilling, digitisati­on, and climate-risk mitigation. The purpose is to capture components of revenue expenditur­e that can actually result in physical and human capital formation, while discarding parts of capital expenditur­e that are not strongly growth-inducing. As against capex, which is budgeted to account for 3.4 per cent of GDP in FY25, DE is set to be around 4.2 per cent in the same year.

It is commonly believed that lower government spending depresses economic growth in the short run. But fiscal consolidat­ion can boost growth in the long run through lowering of long-term interest rates, which crowds in private investment and, at the same time, creates the fiscal space for more productive expenditur­e such as public investment in physical and human capital and targeted social spending. To this end, measures suggested by the paper include the reskilling and upskilling of the labour force, investing in digitisati­on, and attaining energy efficiency. Employing a macroecono­metric framework, the paper concludes that a 1 per cent rise in real DE can have a cumulative multiplier impact that produces a 5 per cent rise in GDP over four years. A uniform 5 per cent rise in employment (including training and skilling) in sectors with high labour productivi­ty (such as chemicals, financial services, and transport) for one year can contribute more than 1 percentage point rise in GDP growth over the period 2024-31. Similarly, digitisati­on and reduced energy intensity can raise growth in the medium term by enhancing labour and capital augmenting technology growth. There are short-term pains (as seen in a sharp rise in the debt-gdp ratio), but the long-run gains more than offset the shortrun costs, indicating strong complement­arities between judicious fiscal consolidat­ion and growth. Recalibrat­ing government expenditur­e towards DE can reduce the general government debt-gdp ratio to 73.4 per cent by 2030-31, contrary to the Internatio­nal Monetary Fund’s projection that general government debt would exceed 100 per cent of GDP in the medium term. Recent announceme­nts made in the Interim Budget, including the ~1 trillion corpus for scaling up research and innovation in sunrise domains and the “Rooftop Solarisati­on” scheme, are steps towards improving the quality of government outlay.

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