State Finances

Abstract

Fiscal consolidation has been a key policy concern ever since India embarked on the path of economic reform in the early 1990s. The stress on fiscal consolidation is premised on the hypothesis that the economic crisis of 1991 was an outcome of poor fiscal management during the 1980s (Srinivasan 2003; Bajpai and Sachs 1999).¹ The build-up to the economic crisis seen from the fiscal perspective runs along the following lines. Fiscal expansion helped India break out from its low Hindu rate of growth in the 1980s. This fiscal expansion, however, was backed by borrowed funds rather than by the government’s own revenue and that fact was reflected in the rising fiscal deficit figures throughout the 1980s. Fiscal deficit is not a problem in itself if the returns on the use of the borrowed funds exceed the cost of borrowing. This, however, was not the case in India where a large part of the deficit financed the day-to-day expenditure of government instead of creating productive assets. Continued high levels of fiscal deficit to finance revenue expenditure create macroeconomic imbalances and, as such, have the potential of culminating in a full-scale macroeconomic crisis. Thus it is no coincidence that in the year 1991, when the Indian economy was hit by a macroeconomic crisis, fiscal deficit for the general government was more than 11 per cent of GDP, and inflation (fuelled by high fiscal deficits) was in double digits. Hence, a principal concern in the overall economic reform process was to rein in the fiscal slippage and restore order in government finances through fiscal stabilization.