
From Fragile Five to First Five: India's journey of fiscal consolidation

Summary
Since being labelled among the ‘fragile five’ economices, India has made substantial strides in fiscal discipline, narrowing the fiscal deficit significantly. With targeted spending and increased revenue collection, the government aims for further reductions amid ongoing state-level challenges.Fiscal discipline is a cornerstone of economic stability for any country, and India is no exception. In an era of escalating geopolitical uncertainties and changing trade dynamics, maintaining fiscal discipline has become increasingly critical to shield economies from external shocks and ensure confidence among global investors.
India realized the importance of a controlled fiscal deficit when India was declared as one of the ‘fragile five’ in 2014, as India’s deficit touched 5% of GDP in one of the quarters (in addition to the weakening of other economic fundamentals). Global pundits and market analysts predicted a state of doom and India was stamped as a lost story.
But India turned around its story by quickly working towards building a strong economic foundation. While focusing on all economic parameters made sense, bringing the fiscal deficit down was key since it significantly influences all other parameters. Subsequently, in the budget for 2014-15, measures were taken towards fulfilling the commitment set in the new FRBM regime, where revised targets were set for various fiscal indicators.
The government brought down the fiscal deficit through fiscal consolidation from 4.5% of GDP in FY 2013-14 to 3.4% of GDP in FY 2018-19. Reduced fiscal deficit helped bring inflation down and increased domestic savings. Considered an indicator of a country’s viability and stability as an investment destination, foreign capital inflows improved, and the currency remained stable. Consequently, increased investments helped capacity building, thereby reducing reliance on imports, and increasing export competitiveness, all of which led to improved trade balance. India rose to a position from fragile five to first five in less than a decade.
Then the pandemic
And then the pandemic happened, necessitating an unprecedented increase in government spending worldwide to protect lives and livelihoods. India, too, witnessed a surge in spending to support MSMEs, displaced individuals, and vaccination drives. These essential measures contributed significantly to the deficit, which soared to a record 9.2% of GDP during FY21. However, India’s approach to addressing the crisis was notably distinct from several other nations'.
India adopted a more targeted strategy with subsidies and financial reliefs aimed at specific groups and sectors while channeling resources into capital expenditure (capex). As a result, capex spending rose from 1.6% of GDP (stagnant from FY 2014-15 to FY 2018-19) to 3.2% of GDP in FY 2023-24. This allocation has been directed towards building critical infrastructure, including highways, railways, renewable energy projects, and ports.
Additionally, the government prioritized manufacturing under initiatives like the Production Linked Incentive (PLI) scheme to reduce dependency on imports from certain geographies and bolster self-sufficiency in critical sectors. This strategic focus reflects India’s understanding of the long-term implications of geopolitical tensions and increasingly restrictive trade regulations imposed by industrialized nations on India’s economic well-being.
While the government maintained its prudence on spending, a critical driver of India’s fiscal consolidation has been its success in enhancing revenue mobilization. The government has significantly expanded the tax base, plugged leakages, and digitized the tax collection process. Tax collections have risen sharply from 10% of GDP in FY 2014-15 to 11.8% (BE) in FY 2023-24.
Encouraging trajectory
The trajectory ahead is encouraging but not challenge-free.
India’s efforts in reducing its fiscal deficit brought it down from a high of 9.2% of GDP in FY 2020-21 to 5.6% in FY 2023-24. For the current fiscal year, the government aims to lower it further to 4.9% of GDP—a remarkable achievement, especially considering this is an election year. The government is expected to remain cautious about spending given and bring it down further to 4.5% of GDP by the next fiscal year, as it would like to signal confidence that it has its expenses under control, especially when capital flows have been volatile due to policy changes in the two largest economies.
While the Central government will continue to make progress in reducing its fiscal deficit, states continue to face challenges in maintaining fiscal discipline. The fiscal health of Indian states continues to be under pressure, as per an NSE report, with fiscal deficits exceeding recommended limits (of 3% of GSDP) and a rising debt-to-GDP ratio. State deficits are projected to be at 3.2% in FY 2023-24, but several states remain under severe stress due to rising expenses and falling share of capex spending. Addressing these imbalances will require greater coordination between the Centre and states, along with fiscal reforms tailored to state-specific contexts.
We expect a continued prioritization of capex, improved revenue collection, and greater participation of states in adhering to fiscal discipline.
Dr Rumki Mazumdar is director and economist with Deloitte India.