Monetary prudence; New govt should balance growth with fiscal consolidation

In its first monetary policy announcement after the Lok Sabha election results, the RBI on Friday decided to keep the benchmark repo rate unchanged at 6.5% for the eighth consecutive time and opted for continuation of its stance of ‘withdrawal accommodation.’ The RBI’s focus on building a secure financial system is commendable. Amid the heat and dust of the Lok Sabha elections, the latest CGA (Controller General of Accounts) release on Central government finances has flown under the radar. It shows that the Centre’s actual fiscal deficit for FY24 at 5.6 percent of GDP was lower than the revised estimate of 5.8 per cent in the February budget. It is lower not only in percentage terms (which can happen due to GDP overshooting estimates) but also in absolute terms, with the deficit at 95.3 per cent of revised estimates.

This is a creditable achievement. Historically, central government deficits overshoot revised estimates by wide margins. The good fiscal show in FY24, along with the bountiful dividend from RBI now suggests that the Centre has more than a fighting chance of attaining its fiscal consolidation targets of 5.1 per cent by FY25 and 4.5 per cent by FY26. Buoyant tax collections, which met revised estimates, helped attain deficit targets in FY24. The Centre’s gross tax revenues grew by 13.4 per cent, with growth in personal income tax collections (25 per cent increase) outpacing corporate tax mop-ups (10.4 per cent). Hefty dividends from PSUs helped non-tax revenues significantly overshoot revised estimates. While revenue spending has been trimmed, the expenditure mix has been vastly improved by allocating nearly a fifth of the budget to capital spending.

The crucial point though is that the new government should stick to the fiscal consolidation path. A Lok Sabha mandate suggesting that voters expect more welfare spending and the prospect of NDA’s coalition partners pushing for a populist agenda, may make the task harder. Recent macro tailwinds – whether it is Indian bond yields decoupling from the US, government securities earning a place in global indices or S&P’s outlook upgrade -- are a result of NDA’s adherence to fiscal targets. Foreign bond investors can quickly retreat on fiscal slippages. Hopefully, the unexpected fiscal boost from the RBI dividend will help the Centre squeeze additional welfare spending into the budget without sacrificing the 5.1 per cent deficit target. The RBI decision to continue remaining focused on the withdrawal of accommodation reflects a balanced approach to sustain economic growth while keeping inflation in check. Prudently, it wants to have “greater elbow room" to ensure price stability in Asia's third-largest economy ahead of the new government’s budget.