Fiscal Deficit

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Context

• India’s government will not be able to cut its budget deficit this fiscal year as previously projected, officials said, but will seek to cap the shortfall at last year’s level to prevent a major deterioration in public finances.

Fiscal Deficit

Definition

• Fiscal deficit is the negative balance that arises whenever a government spends more money than it receives in the form of taxes and other revenues.
• It is an indication of the total borrowings needed by the government. While calculating the total revenue, borrowings are not included.

Description

• The gross fiscal deficit (GFD) is the excess of total expenditure including loans net of recovery over revenue receipts (including external grants) and non-debt capital receipts.
• The net fiscal deficit is the gross fiscal deficit less net lending of the Central government.
• Generally fiscal deficit takes place either due to revenue deficit or a major hike in capital expenditure.
• Capital expenditure is incurred to create long-term assets such as factories, buildings and other development.
• A deficit is usually financed through borrowing from either the central bank of the country or raising money from capital markets by issuing different instruments like treasury bills and bonds.

What are components of the fiscal deficit calculation?

The fiscal deficit calculations are based on two components — income and expenditure.

1. Income component: The income component is made of two variables, revenue generated from taxes levied by the Centre and the income generated from non-tax variables. The taxable income consists of the amount generated from corporation tax, income tax, Customs duties, excise duties, GST, among others. Meanwhile, the non-taxable income comes from external grants, interest receipts, dividends and profits, receipts from Union Territories, among others.
2. Expenditure component: The government in its Budget allocates funds for several works, including payments of salaries, pensions, emoluments, creation of assets, funds for infrastructure, development, health and numerous other sectors that form the expenditure component.

Formula for Fiscal Deficit

1. Fiscal Deficit = Total budget expenditure – Total budget receipts excluding borrowings

Or

2. Fiscal Deficit = Revenue expenditure + Capital expenditure – Revenue receipts – Capital Receipts excluding borrowings

Or

3. Fiscal Deficit = Revenue expenditure + Capital expenditure – Tax Revenue – Non Tax Revenue – Recovery of loans – Disinvestment

Or

4. Fiscal Deficit = Total borrowing requirement of the government.

Trend of Fiscal Deficit in India (as % of GDP)

How is fiscal deficit balanced out?

• While a rising deficit is a challenge for the government in the long term, to balance it out in short-term macroeconomics, the government looks at market borrowings by issuing bonds and selling them in through banks. Banks buy these bonds with currency deposits and then sell them to investors. Government bonds are considered an extremely safe investment instrument, so the interest rate paid on loans to the government represents risk-free investment.
• The government also sees a deficit situation as an opportunity to expand policies and schemes, including welfare programmes, without having to raise taxes or cut spending in the Budget.

Implications of Fiscal Deficit

Inflationary Spiral: Borrowing from RBI, increases the supply of money in the economy, which increases the general price level. A prolonged increase in the general price level results in an inflationary spiral, i.e. borrowing from RBI > Increase in money supply > Increase in prices > Inflationary Spiral.

National Debt: Fiscal Deficit gives birth to the national debt. It hampers GDP growth, as a large portion of the national income is spent on repaying past debts.

Vicious Circle of High Fiscal Deficit and Low GDP Growth: When there is a high fiscal deficit constantly, it gives rise to a situation in which GDP growth remains low due to high fiscal deficit and the fiscal deficit remains high due to low GDP growth.

Debt trap: Borrowing leads to two main problems, with respect to the repayment of loan and payment of interest, because the payment of interest again increases the revenue deficit. And more borrowing will be required to finance interest payments which results in a debt trap.

Crowding Out: Crowding Out Effect is an outcome of Fiscal Deficit. It refers to a condition when high government borrowings because of high fiscal deficit, decreases the availability of funds for private investors. This reduces overall investment in the economy.

Erosion of Government Credibility: High fiscal deficit destroys the credibility of the government in both domestic and international markets. This lowers down the government’s credit rating, and the foreign investors will begin withdrawing money that they have invested in the domestic economy. As a result of which GDP is reduced.

FRBM Act

• Enacted in 2003, The FRBM Act sets target for the government to bring down fiscal deficit. It aims to introduce transparency in India's fiscal management systems.
• The Act‘s long-term objective is for India to achieve fiscal stability and to give the Reserve Bank of India (RBI) flexibility to deal with inflation in India.
• The FRBM Act was enacted to introduce more equitable distribution of India's debt over the years.

Key features of the FRBM Act

• The FRBM Act made it mandatory for the government to place the following along with the Union Budget documents in Parliament annually:
• Medium Term Fiscal Policy Statement
• Macroeconomic Framework Statement
• Fiscal Policy Strategy Statement
• The FRBM Act proposed that revenue deficit, fiscal deficit, tax revenue and the total outstanding liabilities be projected as a percentage of Gross Domestic Product (GDP) in the medium-term fiscal policy statement.

As per the requirements of the Act, Centre needs to limit fiscal deficit to 3 per cent of the country's gross domestic product (GDP) by March 31, 2021. While, government's debt should be restricted to 40 per cent of GDP by 2024-25.

The FRBM Act also allows invoking of an escape clause in situations of calamity and national security. In such situations, the government can deviate from its annual fiscal deficit target.

N K Singh Committee's recommendations on Fiscal Deficit

Targets: The committee suggested using debt as the primary target for fiscal policy and that the target must be achieved by 2023.

Fiscal Council: The committee proposed to create an autonomous Fiscal Council with a chairperson and two members appointed by the Centre (not employees of the government at the time of appointment)

Deviations: The committee suggested that the grounds for the government to deviate from the FRBM Act targets should be clearly specified

Borrowings: According to the suggestions of the committee, the government must not borrow from the RBI, except when the Centre has to meet a temporary shortfall in receipts RBI subscribes to government securities to finance any deviations RBI purchases government securities from the secondary market

Some Key Differences

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