Why in the News?

The central government has announced the shift towards “debt-GDP ratio” as the fiscal anchor beginning from 2026-27 financial year.

What’s in Today’s Article?

• Background (Context of the Article)
• Debt-GDP Ratio (Rationale Behind Shift, Fiscal Consolidation Strategies, Impact of Fiscal Deficit, Concerns, etc.)

Background:

• In a significant shift in fiscal policy, the Indian government has announced that it will replace the fiscal deficit target with the debt-to-GDP ratio as the primary fiscal anchor from FY 2026-27.
• This move aims to ensure fiscal sustainability, enhance transparency, and provide greater flexibility in managing public finances.
• The government has set a long-term target of reducing the central government’s debt-GDP ratio to 50±1% by March 31, 2031.

Debt-GDP Ratio: A New Fiscal Approach

• The debt-to-GDP ratio measures the share of a country's national debt in relation to its Gross Domestic Product (GDP). It serves as a reliable indicator of fiscal health, capturing both past and present borrowing trends.
• According to the Union Budget 2025, the central government’s debt-GDP ratio is projected to:
  • 57.1% in FY 2024-25 (Revised Estimate)
  • 56. 1% in FY 2025-26
  • Declining towards 50% by FY 2031
• The move aligns with global best practices and ensures a long-term fiscal consolidation strategy rather than focusing solely on annual deficit reduction.

Rationale for the Shift to Debt-GDP Ratio:

• More Reliable Fiscal Performance Measure: It captures the cumulative effects of past fiscal policies, unlike the annual fiscal deficit target, which provides a short-term snapshot.
• Greater Fiscal Transparency: The new approach aims to reduce off-budget borrowings and improve clarity in public debt reporting.
• Operational Flexibility: It allows the government to respond to economic shocks and unforeseen developments more effectively than rigid annual deficit targets.
• Debt Sustainability and Growth: A structured debt-reduction path will create fiscal space for productive investments in infrastructure, social welfare, and economic development.

Fiscal Consolidation Strategies: Mild, Moderate, and High Approaches

• To achieve the debt-GDP reduction target, the government has outlined three scenarios based on different nominal GDP growth rates:
• 
• This approach allows flexibility in choosing mild, moderate, or aggressive fiscal consolidation, balancing growth needs with debt sustainability.

Impact on Fiscal Deficit:

• The fiscal deficit target for FY 2024-25 is estimated at 4.8% of GDP, lower than the original target of 4.9%. For FY 2025-26, the government has projected a further reduction to 4.4% of GDP.
• Under a moderate fiscal consolidation strategy, the fiscal deficit is expected to decline:
  • 4.4% in FY 2026
  • 3.5% in FY 2031
• While this represents a gradual improvement, experts caution that reaching the Fiscal Responsibility and Budget Management (FRBM) Act target of 40% debt-GDP ratio will take longer than expected.

Expert Analysis and Concerns:

• Longer Transition Period: Experts argue that achieving a 40% debt-GDP ratio will require several decades, raising concerns about delayed fiscal commitments.
• Private Sector Borrowing Constraints: With a fiscal deficit of 4.4% and state governments contributing an additional 3.3%, there is limited room for private and non-governmental sector borrowing. This could lead to increased foreign borrowing and higher current account deficits.
• Fiscal Space for Growth: The transition to a debt-based fiscal strategy is expected to free up resources for infrastructure investments, welfare programs, and innovation-driven initiatives.

Conclusion:

• The Union Budget 2025 marks a major shift in India’s fiscal policy, replacing fiscal deficit targets with a more flexible and transparent debt-GDP ratio approach.
• While this strategy provides long-term fiscal stability, its success depends on nominal GDP growth, effective fiscal management, and global economic conditions.
• The challenge remains in achieving sustainable debt reduction while ensuring adequate investment in development and economic expansion.
• India’s ability to strike this balance will define the success of this fiscal transformation.