Fiscal Deficit: Meaning and Concept

The term Revenue deficit and fiscal deficit are being used in the Government of India Budget since the fiscal year 1997-98. Fiscal deficit is the difference between total expenditure and total revenue receipts including recoveries of loans and other receipts.

Fiscal Deficit = Total Expenditure – (Revenue Receipts + Recoveries of Loans + Other Receipts)

or

Fiscal Deficit = (Revenue Expenditure + Capital Expenditure) – {(Tax Revenue + Non Tax Revenue) – + Recoveries of Loans + Other Receipts}

Funding of Fiscal Deficit

The rising fiscal deficit has dominated all discussions on the budget in recent years. The biggest question is that if there is an excess of government’s expenditure over its tax and non-tax revenues, where it will be funded from? The answer is that the excess of the government expenditure has to be met with borrowings from the public. To be exact, this borrowing is called fiscal deficit, which is usually expressed as a percentage of GDP.

This also means that a high fiscal deficit runs the risk of government cornering the bulk of the savings, leaving little for corporate and other borrowers (crowding out). Prolonged periods of high fiscal deficit run the risk of raising interest rates and inflation and depressing growth. A deficit of 3% of GDP is seen as sustainable.

  • A deficit budget shows that the government proposes to spend more in the coming year than its receipts. A surplus Budget shows that Government will get more receipts and spend less.
  • In a developing country like India, the Government always seeks to present a “deficit budget” because it intends to spend more (on development) than what its receives. This is because; the deficit budget symbolizes the concerns of the Government towards the development activities. In India a surplus budget was NEVER presented.

Current Year Targeted Fiscal Deficit

For 2017-18, Indian Government has aimed to contain the fiscal deficit at 3.2 per cent of the GDP.

Deficit Financing

The Government, when proposes a deficit budget is well aware of the fact that its total expenditures are going to be more than its receipts. So, it adopts the policies and process which can sustain the burden of the deficit. The process of supporting the budget deficit of the country is called Deficit Financing. There are several methods of Deficit Financing such as:

  • Borrow from domestic or foreign sources
  • Draw upon its foreign exchange reserves
  • Print an equivalent amount of money.

Any of the above three activities would tend to influence other economic variables. The following observations must be noted in this context:

  • In a general sense, excessive printing of money leads to inflation. This is because when government prints too much money, its purchasing power goes down and a situation of too much money choosing too few goods
  • If the government borrows too much from abroad, it leads to a debt crisis. The money that has been borrowed from abroad comes on sovereign guarantee and is called Sovereign Debt. Governments usually borrow by issuing securities, government bonds and bills. However not all governments can borrow by these methods. The less creditworthy countries need to borrow directly from World Bank or other financial institutions. The debt may be short term or long term. Inability to service the debt may result in Sovereign Default which is another name of Debt Crisis.
  • If the government draws down on its foreign exchange reserves, a Balance of Payments crisis may arise. Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country’s exports and imports of goods, services, financial capital, and financial transfers. A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation’s currency.
  • Excessive domestic borrowing by the government may lead to higher real interest rates and the domestic private sector being unable to access funds resulting in the “crowding out” of private investment.

The above discussion makes it clear that it is not prudent for a government to run an unduly large deficit. But at the same time, for a developing country like India, it is also not prudent to have surpluses at the cost of long-term growth. This is because the need for infrastructure and social investments is substantial. So, the most developing country governments have the biggest challenge to meet infrastructure and social needs while managing the government’s finances in a way that the deficit or the accumulating debt burden is not too great.

Domestic Borrowing Versus External Borrowing

Government in India prefers external funding of the Deficit Budget because External Borrowing is cheaper in long term and comes in foreign exchange, which the Government can use to meet its fiscal deficit. The Government also prefers borrowing from the external sources because if it only resorts to the internal borrowing, there may be a problem of liquidity in the country. External grant comes as free, but in recent years, external grant has been very low.

Why printing of currency is used as a last resort?

Printing Currency is used by the Government as last resort in deficit financing. The printing of currency has its own side effects such as increasing inflation and pressure on the Government for upward revision of the wages. Further, printing currency does not meet the expenditures which are needed to be met with foreign currency only.

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