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A tightrope- walk with fiscal deficit

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Fiscal Deficit

The excess of the central government’s expenditure over revenue is a challenge in the slowdown

By: Tavaga Research

Recent estimates of the fiscal deficit are adding to the despair about the state of our economy. The fiscal deficit of India has already shot up multiple times the government’s target, with four more months in the fiscal left.

Financial Year Gross fiscal deficit as a percent of GDP (in percentage)
FY 2015 4.1
FY 2016 3.9
FY 2017 3.5
FY 2018 3.5
FY 2019 3.4
FY 2020* 3.3
FY 2021** 9.5
FY 2022 (Expected) 6.8

* Revised estimate

** Budget Estimate

Source: Statista, Tavaga Research

Fiscal Deficit India

A well-known fact in economics is that economic prosperity does not follow a linear upwards trend; it often experiences bouts of booms and busts. This tendency, to frequently tread away from the path of full employment, necessitates intervention by the government, to guide the economy back on that path. In an attempt to accomplish that objective, the government wields a potent macroeconomic tool, known as the fiscal policy.

Fiscal policy is essentially the use of government spending and taxes to achieve a desired economic output. When an economy is in the grips of a recession, the government can expand its spending or bring down the taxes, increasing the disposable income in the hands of the consumers, leading to increased spending and hence recovery from the recession. The opposite is true for an overheated economy.

What is the fiscal deficit?

Like every household, the government must also balance its revenue and expenditure otherwise, it risks running out of money. Now, this is where the trick lies, unlike households, the central government can always increase the taxes. When the government spends more than it collects in tax receipts, instead of being called bankrupt, the government is said to be running a fiscal deficit.

Technically, a fiscal deficit implies the planned earnings shortfall in the government’s coffers in a fiscal (or financial year).

To the question of ‘What do you mean by fiscal deficit?’, we may answer that it is the planned earnings shortfall in the government’s coffers in a fiscal (or financial year). 

The most important fiscal deficit number is that of the Union government, even though state governments also have their own federal estimates.

Fiscal deficit, expressed in value terms, measures how much a government’s expenditure is more than its receipts. The metric often used for representing fiscal deficit is a  percentage of the country’s GDP.

The Union government’s estimates for fiscal 2021 are being weighed down by a shortage in revenue collection and a slowdown in exports.

The most important fiscal deficit number is that of the Union government, even though state governments also have their own federal estimates. The metric often used for representing fiscal deficit is a percentage of the country’s GDP.

Stability lead to instability
Source: Tavaga

Fiscal deficit meaning 

In the government’s own words, the fiscal deficit of India is the “the excess of total disbursements from the Consolidated Fund of India, excluding repayment of the debt, over total receipts into the Fund (excluding the debt receipts) during a financial year”.

The Consolidated Fund of India is the primary government account out of which all government expenditure is done and in which all revenue is deposited, except for exceptional items. 

How is fiscal deficit calculated?

Fiscal deficit formula – What is the formula of fiscal deficit in India?

Mathematically, the fiscal deficit will be defined as:-

Fiscal deficit = Government expenditure – Government receipts excluding borrowings

The fiscal deficit formula can be further elaborated in the following manner:

Fiscal Deficit = (Total Expenditure both on Revenue Account and Capital Account) – (Revenue receipts + Non- debt Capital Receipts)

where,

Revenue receipts include collection on goods & service tax, corporate tax, income tax, customs duties and union excise duty, etc.

Non-debt capital receipts include interest receipts, dividends and profits, external grants, other non-tax revenue, and receipts of the union territory, etc.

Expenditures of the government can be divided into capital expenditure and revenue expenditure.

Capital expenditure is incurred while building national assets such as industries, economic zones, transport, and other infrastructure, spending on defense, disbursing grants, and aid to state governments. 

Revenue expenditure refers to all the transfer payments (payments made to citizens, without taking any service in return such as subsidies, pension), factor payments (payments made to citizens for rendering their services), and servicing of loans taken out by the government. Revenue expenditure refers to all spending that does not create assets or reduces liabilities.

The fiscal deficit shows the amount that would need to be borrowed by the government to meet its expenditure.

Receipts mean the income of the government received through taxes such as both direct and indirect, custom duties on imports, excise duties, union territory-taxes, and GST, and other sources. 

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Some of the other sources include investments that are received in a PPP (Public-Private Partnership) or in a company wholly-owned by the central government, international grants, interest receipts, profits, and dividends of the public sector units, receipts from union territories, and income from license fees. Receipts are another term for revenue here. 

We say the fiscal deficit is widening if the value increases from that of the previous year’s. 

What causes fiscal deficit?

India has been consistently running on a fiscal deficit for a very long time. Its low per capita income, compared to many other economies, has meant it has a sizeable poor population. The government has to spend regularly on subsidies for and aid to the economically backward. At the same time, tax evasion is rampant in India, no matter the tax bracket. 

The central government has a number of ways at its disposal to keep the fiscal deficit in check. It could either have to do with decreasing spending or increasing its revenue, and off-budget borrowings (not presented in the fiscal’s Union budget). The Union government may decide to increase or decrease the fiscal deficit, depending upon the state of the economy and the actions needed of it.

When an economy is facing slowdown and unemployment at the same time then the government may decide to lower taxes, increase capital expenditure, and support various businesses through sops and aid. This spurs business activity, generating employment and aiding demand, and in turn raising the GDP.

But simultaneously, the fiscal deficit widens because of the decrease in the revenue of the government due to fewer taxes, and an increase in the overall spending. Hence, a widening fiscal deficit is not always bad news.

However, there needs to be a limit as well. A large fiscal deficit may lead to a debt trap. A debt trap occurs when a country needs to borrow from sources to service its loans. 

The method for lowering fiscal deficit includes raising taxes and cutting capital and revenue expenditures. These measures, while reducing the deficit, work to slow down an economy at the same time.

With raised taxes, businesses tend to curtail their activity (production) to avoid higher payouts in taxes. Consumers spend less to avoid incurring personal (indirect) taxes and to save more. The economy, sustained by a healthy demand-supply equation, gets hit. With economic activity grinding to a slower pace, unemployment creeps in, further damaging it.

A large fiscal deficit for a developing country like India can shake up its economy because the balancing and rebalancing take up a lot of vital resources. It becomes a tad imperative for the Union government to maintain a steady (without too much fluctuation) fiscal deficit.

Fiscal deficit and revenue deficit

Source: Tavaga Research

What is the difference between fiscal deficit and budget deficit?

A budget deficit is a difference between all expenses and receipts in both the capital and the revenue account of the government. It is the sum of revenue account deficit and capital account deficit. Revenue deficit occurs when revenue receipts are less than revenue expenditure that the government incurs. Similarly, a capital account deficit occurs, when, capital disbursements exceed capital receipts. It is usually expressed as a percentage of GDP.

The Fiscal deficit is as measured above. However, the fiscal deficit measure is the preferred metric rather than a budget deficit measure.

How is fiscal deficit met?

  1. The central government can borrow money from the financial markets
  2. The government can always increase taxes to meet any shortfall in revenue.

The above-mentioned sources have a various and differentiated impact on the economy, so the choice of the source to fund the fiscal deficit is an important bearing for the investors

Current fiscal deficit of India

Fiscal Deficit of India 2020

The government in February had pegged the fiscal deficit at 9.5 percent of GDP for the fiscal year 2020-21 as against the budgeted 3.5%. Having targeted a fiscal deficit of 3.3 percent in the last fiscal year, i.e. 2019-20, the government overshot that target by almost 110 basis points on account of poor revenue realization.

This year again, given the COVID-19 induced lockdown and the drastic fiscal measures announced by the government to support the livelihood; the government is expected to overshoot its budgeted deficit targets.

For the year 2021-2022, the government has pegged the fiscal deficit to 6.8% of the GDP owing to the increased spending due to Covid-19 disruptions. The government is expected to reduce the fiscal deficit by 4.5% of the GDP by 2025, as stated by the Finance Minister.


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