There are three important reasons why the Indian economy is stagnant today: a monetary policy which is not synchronised with the fiscal; disconnect with the rest of world in real terms in an increasingly open economy; and mistaking risk aversion for sustainability (of government debt and deficits).

Our Fiscal Responsibility and Budget Management obligations are forcing the government think more like an individual in retirement mode: pay off debts and resist fresh ones, as if its sources of income are to dry up soon.

Considering the the country’s strengths, the following actions may be taken for getting out of the current rut. The aim is to have integrated fiscal and monetary policies. The sustainability of these are demonstrated later.

The RBI should maintain real interest rates (RIR) at +/- 0.5 per cent of select competing countries/economies. This will preserve India as an attractive investment destination for inbound investments, besides staying competitive for domestic investors.

This has become disengaged of late due to nominal anchoring in an open economy, as can be seen in the chart.


Since 2013, India’s real interest rates have gone off into a different orbit.

The RBI must target a GDP deflator of 6 per cent per annum for the medium term. This together with an internationally aligned RIR will establish the target nominal interest rates. Within this, food and essential inflation may be targeted at 3-4 per cent to ‘protect the poor’.

The government should aim at a tax-GDP ratio that is in line with other countries (those chosen for real interest rates) — and increase it by 2-3 percentage points over the next five years.

Fix the target real growth rate at 7 per cent, and peg the government expenditure growth at 7 per cent as well. If government spending continues to grow at 7 per cent when the economy is growing at 10 per cent, lower spends will cool the economy.

When the economy is growing at 4 per cent, the higher spend will act as a booster —an automatic stabiliser.

The Centre should increase its debt levels to 52.5 per cent of GDP from the present 47.8 per cent. The overall debt limit should be 60 per cent, with 7.5 per cent being kept as ‘cushion’ to be tapped only for tackling extreme exigencies, such as prolonged war, events like oil shocks, extreme natural national calamities, 1997/2008 type of contagious external shocks, etc.

Any such deviation should be corrected within two years, restoring the anchor assumptions of 7 per cent real growth and a GDP deflator of 6 per cent.

The government should switch over to accrual-based accounting from cash accounting and integrate extra budgetary resource (EBR) within the meaning of fiscal deficit.

As a result of the EBRs, there are multiple agencies placing essentially the same instrument and due to which the pricing power of the Central government gets diluted.

Although industry and agriculture are State subjects, the Centre can play the stabilisation and balancing roles for business cycles.

Subsidy list and quantum must be agreed to by the States and the Centre. Subsidies should be limited to basic necessities of food, clothing, shelter, and creating conditions for equality of economic and social opportunities, including education, skills, basic healthcare and hygiene.

All other subsidies should be part of the State budget for which a limit, say, as a percentage of GSDP, should be applied. No subsidies should be mandated on non-government players.

Sustainable glide path

The above are tested for sustainability of debt/GDP levels and primary/fiscal deficits. These are demonstrated below using standard equations laid out by the IMF, Economic Survey (2016-17) and the FRBM review committee report.

The government should increase its debt to 52.5 per cent in three years. This would involve much higher primary deficits on which additional interest will have to be paid. The government’s revenues grow at nominal rates of, say, 13 per cent year on year.

But primary deficits which add to debt have to be serviced at 7-8 per cent only. So one has to balance and equate the additional taxes with serving costs of PD (primary deficit).

This is signified by the FRBM review in its report as pd t = (gt - rt )/(1 + gt )*dt (derived from the equation in page 54 of the report), where pdt is primary deficit at time t, gt is nominal growth rate at time t, rt is the nominal rate of interest at time t, and dt is debt/GDP ratio.

Table 1 captures the sustainability. It shows that a primary deficit level of 2.3 per cent is consistent with 52.5 debt/GDP levels and 8 per cent GOI borrowing rate. Applying the above formula, PD = (0.13-0.08)/(1+.13) * 52.5=2.3.


Based on the above assumptions it is possible to sustain a fiscal deficit of 6 per cent at the Central Government level alone (see Table 2).

If we want to rein in the States, we can mandate them to maintain nil primary deficits. The sustainable fiscal deficits are given by FD s = D t * (g/1+g), where FD is sustainable fiscal deficit and g is nominal growth rate.

Table 2 lays out the sustainable debt levels across various growth rates and debt levels. Table 3 lays down the glide path based on above recommendations.



The switch over from cash to accrual accounting might gobble up ₹2-3 lakh crore, which is accommodated by the higher PD targets in Year 1.

Since there would be already ‘incurred’ expenditure the inflation effect will be muted. By Year 2, it can keep ready viable public projects. As can be seen, it is eminently feasible.

The writer is author of ‘Making Growth Happen in India’