Model Answer
0 min readIntroduction
Fiscal consolidation refers to the set of policies undertaken by governments at all levels to reduce their deficits and accumulation of public debt, ensuring long-term macroeconomic stability and sustainable growth. In India's federal structure, the Finance Commission, a constitutional body established under Article 280, plays a pivotal role in recommending the distribution of financial resources between the Union and the States, and among the States themselves. The 15th Finance Commission (FC-XV), which submitted its report for the period 2021-26, has provided a comprehensive roadmap that significantly aligns with the government's broader fiscal consolidation goals, aiming to instill fiscal discipline across both central and state finances.
The recommendations of the 15th Finance Commission are intricately designed to promote fiscal prudence and strengthen the financial health of both the Union and State governments, thereby directly contributing to the overarching goal of fiscal consolidation. This alignment is visible through several key measures:
1. Fiscal Deficit and Debt Path
- Targeted Reduction for Centre: The FC-XV recommended that the Centre reduce its fiscal deficit to 4% of GDP by 2025-26. This target is a crucial step towards reining in central government borrowing and ensuring fiscal sustainability, especially after the elevated deficits during the COVID-19 pandemic.
- Phased Reduction for States: For states, the Commission proposed a phased reduction of fiscal deficit to 4% of GSDP in 2021-22, 3.5% in 2022-23, and 3% from 2023-26. This staggered approach provides states with a glide path to fiscal discipline while acknowledging their immediate financial challenges.
- Debt-to-GDP Ratio Focus: The government, aligning with the spirit of these recommendations, has shifted towards making the debt-to-GDP ratio the primary anchor of its fiscal consolidation strategy from FY27, aiming to reduce the debt-to-GDP ratio to 50% (±1%) by March 2031.
2. Review of the FRBM Act and Fiscal Framework
- High-Level Inter-Governmental Group: The 15th Finance Commission recommended forming a high-level inter-governmental group to review the Fiscal Responsibility and Budget Management (FRBM) Act. This group is tasked with proposing a revised FRBM framework for both the Centre and states and overseeing its implementation. This institutional reform aims to strengthen rule-based fiscal management.
- Independent Public Debt Management Cells: It suggested that State Governments explore forming independent public debt management cells to chart their borrowing programs efficiently, thereby enhancing fiscal accountability and prudent debt management at the state level.
3. Borrowing Limits for States
- Normal Borrowing Limits: The Commission proposed fixing the normal limit for net borrowing at 4% of GSDP in 2021-22, 3.5% in 2022-23, and 3% from 2023-24 to 2025-26. These limits, while providing some flexibility, enforce a ceiling on state borrowing to prevent excessive debt accumulation.
- Performance-based Additional Borrowing: An additional borrowing of 0.5% of GSDP was allowed for states that undertake power sector reforms, incentivizing structural improvements that can reduce fiscal stress in the long run. This links fiscal flexibility to tangible reforms, a key aspect of fiscal consolidation.
4. Grants-in-Aid and Performance Incentives
- Revenue Deficit Grants: The Commission recommended post-devolution revenue deficit grants amounting to approximately Rs. 2.94 lakh crore over the five-year period for seventeen states. While these grants address fiscal imbalances, they are structured to allow states to meet their essential expenditure without resorting to excessive borrowing.
- Sector-Specific and Performance-Based Grants: Grants were recommended for various sectors like health, education, and local bodies. Furthermore, performance-based incentives were introduced for states demonstrating reforms in areas like power, health, and agriculture, encouraging efficient expenditure and improved service delivery, which indirectly contributes to fiscal health by optimizing resource utilization.
- Rationalization of Centrally Sponsored Schemes (CSS): The FC-XV suggested fixing a minimum funding threshold for CSS and phasing out schemes with limited impact. This aims to improve the efficiency of public spending and ensure that resources are directed towards more impactful programs, thereby enhancing fiscal consolidation.
5. Tax Devolution and Revenue Mobilization
- Vertical Devolution: The Commission recommended a vertical devolution of 41% of the divisible pool of central taxes to states for the period 2021-26 (adjusted from 42% of the 14th FC to account for the Union Territories of J&K and Ladakh). While states demand more autonomy, this consistent share provides predictability in revenue for states, aiding their financial planning.
- Re-introduction of Tax Effort Criterion: For horizontal devolution, the FC-XV re-introduced the "tax effort" criterion with a weight of 2.5% to reward states that demonstrate better own-tax revenue mobilization, encouraging them to enhance their fiscal capacity.
| FC-XV Recommendation Area | Alignment with Fiscal Consolidation Goals |
|---|---|
| Fiscal Deficit Targets (Centre) | Directly aims to reduce central government borrowing and debt. |
| Fiscal Deficit Targets (States) | Provides a phased roadmap for states to achieve fiscal discipline. |
| FRBM Act Review | Strengthens rule-based fiscal management and accountability. |
| State Borrowing Limits | Imposes ceilings on state debt and links flexibility to reforms. |
| Performance-based Grants | Incentivizes efficient expenditure and structural reforms in states. |
| Tax Effort Criterion | Encourages states to enhance their own-tax revenue generation. |
Conclusion
The 15th Finance Commission's recommendations demonstrate a clear alignment with the government's fiscal consolidation goals by establishing realistic and progressive targets for fiscal deficits, strengthening the fiscal policy framework, and incentivizing prudent financial management at both Union and State levels. By balancing the principles of fiscal federalism with the imperatives of macroeconomic stability, the Commission has laid down a comprehensive blueprint. Successful implementation, coupled with sustained political will and economic growth, will be crucial in achieving the desired fiscal consolidation and ensuring long-term financial health for the Indian economy.
Answer Length
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