Reforms In Major Expenditure Programme Needed To Put Fiscal House In Order

It is expected that India will be the first major trading partner to sign a bilateral agreement with USA within the deadline set by President Trump. The current challenges should be utilised to focus on productive and qualitative improvement of manufacturing sector and to provide further impetus to attract global manufacturers to India and widen our exports to hitherto untapped countries

The ‘World Economic Outlook’ has been released at the right time by the International Monetary Fund (IMF). It has come up with several crucial factors as a run-up to the 2025 Spring Meeting of the World Bank Group and IMF.

These meetings are of significance as it features major discussions involving world leaders, central bank governors, bankers and policy makers.

The World Economic Outlook has analysed the global growth outlook in the light of the current uncertainties due to major trade policy shifts and consequences of the tariff war between USA and China.

According to new estimates, the world output which was at 3.3 per cent in 2024 is now projected downwards at 2.8 per cent this year and three per cent in 2026.

The volatility in equity, bond markets as well as in the forex market are considerable and it could erode a substantial wealth of the investors and result in supply chain disturbances.

The United States’ growth is being projected at 1.8 per cent for 2025 and 1.7 per cent for 2026. Economic growth will be affected in all advanced countries like Germany, France, Italy, and Spain. Advanced economies as a whole will show less growth at 1.4 per cent for 2025 as against 1.8 per cent as at 2024. It is projected at 1.5 per cent for 2026.

It will be likewise with regard to emerging market and developing economies, whose growth was hit from 4.3 per cent at 2024 to 3.7 per cent in 2025 and projected at 3.9 per cent next year.

Emerging and developing Asia, which has a substantial contribution to global growth, is likely to suffer. From 5.3 per cent in 2024, its economic growth has been projected at 4.5 per cent this year and also in 2026.

China will have a steep fall from five per cent in 2024 to four per cent in 2026. India, which has the highest growth in the recent past, registered 6.5 per cent in 2024 which was lesser than the earlier plus eight per cent growth. It is also likely to have an impact due to current trade tariffs and lesser exports. The Reserve Bank of India (RBI) in its recent monetary policy has also projected lesser GDP growth at 6.5 per cent as against the earlier estimated 6.8 per cent.

The impact will be felt more on countries having higher fiscal deficit and those with higher external debt. In the absence of adequate earnings in foreign exchange and less forex reserve, they will find it difficult to withstand the pressure of serving the external debt. It will be quite a task into the future given the high interest rates particularly in the US.

The ‘Global Financial Stability Report’ cautions against an increase in risks to financial stability. The report has highlighted three vulnerabilities: 1. Valuation remains high in some key markets; 2. some highly leveraged financial institutions and their nexus with banking systems and 3. risks of market turmoil and challenges to debt sustainability for highly indebted sovereigns.

There is the likelihood of downside risks to asset price, which could severally impact the emerging markets. As the interest rates in emerging economies are likely to be lowered due to inflation easing, the arbitrage spread over the advanced economies is getting reduced. As a result, there is a greater risk of capital outflow and lesser inflow of foreign funds both to equity and bond markets This will result in the currencies getting depreciated and affect exports. For frontier countries, as the bond yields are firming up, further refinancing of the maturing debt would be at a higher cost.

There is also a risk that highly leveraged financial institutions could come under strain in volatile markets. While the hedge fund and asset management sectors have grown, so have their aggregate leverage levels and nexus with the banking sector from which they borrow.

The third area of possible turbulence is in the sovereign bond markets. The cost of refinancing sovereign bonds may go up in view of higher bond prices and rising fiscal costs.

Meanwhile, geo political tensions will result in higher spending on defence even as there is the problem of getting foreign aid. It is therefore imperative for countries with high debt to aim for fiscal consolidation plan and have medium term plan to bring down the debt levels and build buffers against heightened uncertainties. There is a need to have a control on expenditure and have more focus on quality of expenditure.

The report talks of reforms to major expenditure programs such as energy subsidies and pensions which are crucial to reducing fiscal vulnerabilities while fostering growth, implying that countries must put their fiscal house in order.

India still maintains the fastest growing economy and its macroeconomic fundamentals are strong. India had followed fiscal prudence and the fiscal deficit is estimated to be at 4.4 per cent of GDP by 2026. The government has also set a fiscal management road map by bringing the extent of the central government debt within 50 per cent by 2030. It is expected that India will be the first major trading partner to sign a bilateral agreement with USA within the deadline set by President Trump. The current challenges should be utilised to focus on productive and qualitative improvement of manufacturing sector and to provide further impetus to attract global manufacturers to India and widen our exports to hitherto untapped countries.

The reforms of significance which can bring newer opportunities for greater contribution to our growth like on labour, land, capital and newer technology adoption will be the future growth drivers. Domestically also India's potential growth possibilities are higher.

(The author is former Chairman & Managing Director of Indian Overseas Bank)