India’s Federal Fiscal Policy On Track As The Centre And States Align Consolidation Path

The country’s federal fiscal policy, which refers to government policy in respect of public expenditure, taxation and public debt, has behaved well post-pandemic what with both the Centre and States aligning their consolidation path until recently. States in aggregate managed to be fiscally prudent despite significant pressure on revenue post-pandemic and beyond. They were able to reprioritize expenditure and rapidly contain fiscal deficit despite limited fiscal space, which cemented the onward growth path. For starters, there are three different types of fiscal policies. The objective of expansionary fiscal policy is to reduce unemployment, while also resulting in a better GDP. The contractionary fiscal policy is aimed at reducing inflation. In contrast, the idea behind the neutral fiscal policy is to maintain the status quo in the economy. The role of federal fiscal policy was to the fore since June as the political map has been duly reshaped. Emkay’s recent study of the last 25 years of fiscal and political economy had concluded that economic efficiencies, visible in better resource allocation and reduced populism, are amply reflected in optimization of budgetary choices.

However, a lot has changed since the recent general and state election outcomes, reigniting fears that political capital could get somewhat compromised, which would increase economic dead-weight loss. This merits reviewing the debt and deficit profile of states from the lens of the current fiscal and political space. The country’s fiscal policy is the cornerstone of its economic strategy, which steers it through various phases of growth, development and challenges. It plays a crucial role in shaping the nation's development trajectory, influencing its macroeconomic stability, and addressing socio-economic challenges. Analysts have been arguing that from the states’ POV, multiple fiscal risks remain and vary across one another, especially amid falling grants, emerging stress on own tax revenue, and continued non-merit subsidies like electricity. Such state-specific fiscal vulnerabilities need appropriate policy considerations to enable sustainable fiscal recovery.

With H1 having passed and many states having presented revised/modified budgets for FY25, an analysis of states’ finances was conducted over the years and for FY25 so far to gauge their fiscal capacity, ways, and means to augment revenue space; political proclivity to increase populism-led spending, and implied cost of reforms reversals and its impact on capex. While States’ aggregate FY25BE FD/GSDP is widening to three per cent from 2.8 per cent in FY24P, fiscal and borrowing data available for FY25 so far has not been too disturbing amid various factors, including the Lok Sabha elections. However, experts see reasonable risks of H2 slippage in the last three years, and see the quality of fiscal mix worsening with revenue deficit widening further to 0.5 per cent as against FY24’s projections at 0.3 per cent. This will also imply that total the General Government FD/GDP might consolidate slower in FY25 and may still stay above eight per cent in FY25 as against 8.4 per cent in FY24 presumption, assuming that the centre sticks to 4.9 per cent FD/GDP.