Union Budget 2025: What is the fiscal glide path and why does it matter?

A fiscal deficit is the difference between what the government spends and what it earns.

The fiscal glide path is a plan that helps the government gradually reduce its budget deficit. A budget deficit happens when the government spends more money than it earns through taxes and other revenues. To cover this gap, the government borrows money. If the deficit is too large for too long, it can cause problems for the economy, such as higher inflation (rising prices) and more expensive borrowing.

What is a fiscal deficit and why does it matter?

A fiscal deficit is the difference between what the government spends and what it earns. When the government spends more than it earns, it borrows money to make up the difference. While borrowing is sometimes necessary, if the deficit becomes too high, it can lead to inflation.

Inflation is when the prices of goods and services rise, which means your money doesn't go as far as it did before. If the government borrows too much, it could also raise interest rates, making it more expensive for people and businesses to borrow money.

The fiscal glide path: what is it?

The fiscal glide path is the government’s plan to gradually reduce the fiscal deficit over time. The idea is to get the deficit under control to avoid harming the economy in the future.

India has a target to keep its fiscal deficit at 3 percent of GDP (Gross Domestic Product, which is the total value of goods and services produced) in the long run. This is a common goal in many countries. For example, the European Union has a rule that says its member countries should keep their deficit below 3 percent of GDP.

However, after the COVID-19 pandemic, the government of India realised that it would be difficult to reach the 3 percent target quickly. So, instead of 3 percent, the government set a new goal of 4.5 percent of GDP by 2025-26. This new target accounts for not just the regular expenses but also things like hidden debts or liabilities that were not included in the official budget. By including these, the government hopes to make its budget more transparent and realistic.

What was the original plan?

Before the pandemic, India had set a plan to reduce the fiscal deficit to 3 percent of GDP by 2020. The government had also set targets to bring it down even more over time. However, the pandemic led to an increase in government spending, which made it harder to stick to these targets.

The government had set out a fiscal glide path to reduce the deficit each year. But due to the economic challenges caused by COVID-19, the goalposts have moved, and the new plan is to get the deficit down to 4.5 percent by 2025-26.

Can the government change the target?

Yes, the government has some flexibility to change the target if necessary. The NK Singh Committee, which helped design the fiscal path, allowed the government to deviate by up to 0.5 percent of GDP in exceptional situations. This could include times when the economy is struggling or there’s a national emergency. This flexibility allows the government to respond to unexpected events while still trying to keep the deficit under control in the long term.

Why does the deficit matter for the economy?

If the government keeps borrowing too much money to cover its deficit, it can cause problems. When the government borrows money, it needs to pay interest on that money. If the borrowing goes up, it can lead to inflation, where the prices of things like food, gas, and other goods rise. This means your money doesn't stretch as far as it used to.

Also, when the government borrows a lot, it can make interest rates go up for everyone. This makes it more expensive for businesses to borrow money for new projects or for people to take out loans for things like buying a house or a car. High-interest rates can slow down the economy, making it harder for businesses to grow and for people to spend money.

Key takeaways:

• Fiscal Deficit: When the government spends more than it earns, leading to borrowing.
• Fiscal Glide Path: The plan to reduce the deficit gradually over time.
• Why 3 percent ?: India aims for a fiscal deficit of 3 percent of GDP, a target followed by many countries to avoid negative economic effects like inflation.
• New Target: The target for India is now 4.5 percent by 2025-26 due to challenges posed by the pandemic and other factors.
• Flexibility: The government can adjust its target in special situations, like during an economic slowdown or national emergency.
• Economic Impact: High deficits can lead to inflation and higher interest rates, which can hurt businesses, consumers, and the overall economy.