Using the debt-to-GDP ratio as a fiscal anchor aligns with efforts to promote fiscal transparency through proper disclosure of off-budget borrowings.
In 2018, the central government amended the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, targeting to reduce the fiscal deficit to 3 per cent by 2020-21 (FY21) and the debt-to-gross domestic product (GDP) ratio to 40 per cent by FY25.
The Covid pandemic disrupted these plans, and India's fiscal deficit rose from 4.6 per cent of GDP in FY20 to 9.2 per cent in FY21.
The 2018 FRBM amendment had followed the recommendations of the NK Singh Committee, set up in 2016 to chart a fresh fiscal consolidation roadmap.
Fast forward to 2025. Finance Minister Nirmala Sitharaman, in her FY26 Budget, announced a new glide path, positioning the debt-to-GDP ratio as the fiscal anchor, moving away from targeting fiscal deficit.
The government now aims to reduce the debt-to-GDP ratio to 50 per cent by FY31, with a one percentage point deviation on either side.
Economic Affairs Secretary Ajay Seth explained in a post-Budget interview that while each Budget will specify a fiscal deficit figure, it will be a "derived number" based on the debt-to-GDP target.
This contrasts with the 2018 FRBM amendment, which laid down that the "government will simultaneously target debt and fiscal deficit, with fiscal deficit as an operational target".
The proposal
The debt-to-GDP ratio for FY27-FY31 is based on three nominal GDP growth scenarios of 10 per cent, 10.5 per cent, and 11 per cent.
For each scenario, there are mild, moderate, and high debt-to-GDP ratio targets, depending on the level of fiscal consolidation targeted.
The six-year roadmap aims to reduce the debt-to-GDP ratio from 57.1 per cent in FY25 to a range of 47.5-52 per cent by FY31.
For FY26, the Budget pegs the debt-to-GDP ratio at 56.1 per cent, assuming nominal GDP growth of 10.1 per cent, effectively aiming to bring it down by 1 percentage point in a year.
"This approach would provide requisite operational flexibility to the government to respond to unforeseen developments. At the same time, it is expected to put the central government debt on a sustainable trajectory in a transparent manner," said the Medium Term Fiscal Policy cum Fiscal Policy Strategy Statement presented along with the Budget.
In her Budget speech, Sitharaman said, "Our endeavour will be to keep the fiscal deficit each year such that the central government debt remains on a declining path as a percentage of the GDP."
The government aims to reduce the fiscal deficit from the revised 4.8 per cent of GDP in FY25 to 4.4 per cent in FY26.
Previously, the FY22 Budget had set a glide path to bring the fiscal deficit below 4.5 per cent of GDP by FY25.
"Sans any major macroeconomic disruptive exogenous shock(s), and while keeping in mind potential growth trends and emergent development needs, the government would endeavour to keep fiscal deficit in each year (from FY27 till FY31) such that the central government debt is on declining path to attain a debt-to-GDP level of about 50±1 per cent by 31st March 2031 (the last year of the 16th Finance Commission cycle)," the statement said.
It added that using the debt-to-GDP ratio as a fiscal anchor aligns with efforts to promote fiscal transparency through proper disclosure of off-budget borrowings.
And that it is in line with global thinking, encouraging "the shift from rigid annual fiscal targets towards more transparent and operationally flexible fiscal standards".
The statement said this was recognised as a more reliable measure of fiscal performance as it captures the cumulative effects of past and current decisions.
This strategy, it explained, was expected to rebuild buffers and provide space for growth-enhancing expenditures.
Experts weigh in
DK Srivastava, chief policy advisor at EY India, said the discontinuation of the fiscal deficit glide path amounts to shifting from a transparent to a less transparent indicator.
"Fiscal deficit comes first. One decides annual borrowing, which determines annual debt -- not the other way around," he said.
Pronab Sen, former chief statistician of India, said the two indicators serve different purposes based on the macroeconomic conditions one is trying to address.
"When you focus on the debt-GDP ratio, you are trying to hold down the level of interest that comes in every year's Budget," he said.
Fiscal deficit, he added, matters as it represents government borrowing, affecting whether it crowds in or out private investment.
"With low private investment, a high fiscal deficit is actually a good thing. As private investment picks up, the fiscal deficit should be reduced to create space," he explained.
Srivastava argued that the government should have outlined a plan to achieve the 40 per cent debt-to-GDP ratio and 3 per cent fiscal deficit as envisaged in the FRBM Act.
"When annual reduction of debt-to-GDP ratio is the target, then even with a fiscal deficit of 4.4 or 4.3 per cent, marginal decreases might meet annual debt reduction targets. Therefore, we can be considerably removed from the FRBM targets for years and the government finances could still remain well above sustainability levels, despite a declining debt-to-GDP ratio. So focusing on annual reductions alone isn't enough," he explained.
Sen said the government should disclose annually whether it is pursuing mild, moderate, or high consolidation.
Regarding states, Seth said the government won't push them to adopt debt-to-GDP as the fiscal anchor.
"Our guidance is for states to keep fiscal deficits within 3 per cent of GSDP (gross state domestic product), and guide them towards capital orientation rather than a revenue one."
Sen agreed it would be sensible for states to focus on debt as the fiscal anchor, given many run high debt-to-GSDP ratios. However, Srivastava pointed out that the Centre cannot mandate this transition.
"States have their own fiscal responsibility legislations, most with a 3 per cent fiscal deficit target. Even if the Finance Commission recommends shifting to debt-to-GDP, it remains advisory and doesn't change legislation," he said.
Sovereign rating implications
While most rating agencies were positive about India's fiscal anchor shift, their assessments of the impact on the country's sovereign rating varied.
Fitch Ratings said that confidence in the government's adherence to its medium-term fiscal framework and debt reduction could eventually lead to upward pressure on India's rating.
However, it cautioned that "plans for a gradual pace of debt reduction could leave the authorities with little room to respond to shocks without putting debt reduction targets at risk".
Moody's Ratings said that while a downward debt trajectory would enhance policy credibility, the projected improvements might not significantly alter its broader assessment that India's fiscal strength will remain weaker than most of its Baa-rated peers.
"Over the next two years, we continue to expect India's general government deficit, which combines the fiscal position of the central and state governments, to remain among the widest when compared to Baa-rated emerging market peers, rendering India's debt burden higher and debt affordability weaker," it maintained.
S&P Global Ratings indicated that an upgrade would require a meaningful narrowing of fiscal deficits, reducing the net change in general government debt below 7 per cent of GDP structurally.
"This may improve the fiscal flexibility and performance score. But a lower debt-to-GDP ratio for India would not necessarily lead to an improved debt burden score. This is due to the country's very high ratio of government interest servicing to revenue," it cautioned.
For rating agencies, the key will be tangible reductions in both the debt-to-GDP ratio and the fiscal deficit.
Feature Presentation: Aslam Hunani/Rediff.com
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