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Illustration by Sidra Dahhan

Fiscal Consolidation; what is it and why do we need it?

The Covid pandemic impacted many countries’ economic stability, and now that they are finally starting to recover, it is important to understand what strategies governments can employ to achieve full financial recuperation.

As economies gradually come out of the Covid-19 pandemic and the economic shocks of 2021 and 2022, fiscal consolidation is a term heard across the world. This article attempts to simplify the process and looks into what it takes for countries to reach their goals. Fiscal consolidation means attempts to reduce a country’s fiscal deficit. To understand fiscal consolidation, we have to first understand what fiscal deficit means. A fiscal deficit is the difference between a government's total revenue and expenses in a given fiscal year. As revenue dropped and expenses grew in the past few years, most countries face high fiscal deficits, stressing the needs for fiscal consolidation. If a government runs a fiscal deficit for an extended period, it can lead to an accumulation of debt and potentially lead to inflation.
It is essential to note, however, that a fiscal deficit does not mean that the country is not economically sound. If the government is spending on developmental projects like constructing highways, airports, or industries that will contribute to its income in the coming years, then its current fiscal deficit can be high. Hence, while looking at the fiscal deficit figure, it is essential to analyze the composition of revenue and expenses as well.
How do governments implement fiscal consolidation?
As we saw above this can be done in two ways; increasing revenue and decreasing expenditure. One of the most obvious means for countries to increase their revenue is through increasing taxes. However, this is a politically unfavorable move which pushes countries to amass revenue through borrowing. This too is increasingly unlikely however due to unsustainable debt levels in most countries which hamper their ability to borrow further. With such difficulties in increasing revenues, countries rely mostly on expenditure cuts to reach their fiscal goals. For example, this may involve cutting back on subsidies and reducing the number of government employees. The government also disinvests or sells its stake in public sector enterprises to raise money. This can be done through strategic sales or listing these public companies on the stock market. The government can also encourage public-private partnerships to increase revenue and reduce expenditure. This can involve private companies investing in infrastructure projects or taking over the management of public services.
Where next?
An ideal fiscal balance depends on various factors, such as economic growth, inflation, debt, and social welfare programs. Therefore, a balance must be struck between stimulating economic growth and maintaining fiscal sustainability in the long term. However, there are different views on an optimum level. Some experts argue that a high fiscal deficit is necessary to stimulate economic growth and create jobs. Nevertheless, others say that a high fiscal deficit is unsustainable in the long term and can lead to inflation and debt. It is further complicated for developing countries where a higher fiscal deficit is necessary to fund social welfare programs and infrastructure projects to reduce poverty and improve the standard of living but simultaneously face the burden of unsustainable debt levels.
It is no secret, however, that stimulus packages in the past few years will not be sustainable in the long run and that therefore countries will have to embrace fiscal consolidation. Therefore, governments must increase revenue through tax reform and increased financial investments to address this issue. Additionally, efforts must be made to reduce unnecessary spending and prioritize essential public services.
Sachintha Pilapitiya is Deputy Columns Editor. Email him at
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