The excess of the central government’s expenditure over revenue is a challenge in the slowdown
Source: Tavaga Research
Recent estimates of 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 two more months in the fiscal left.
What is fiscal deficit
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 by 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 2020 are being weighed down by a shortage in revenue collection and a slowdown in exports.
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.
Fiscal deficit formula
Mathematically, fiscal deficit will be defined as:-
Fiscal deficit = Government expenditure – Government receipts excluding borrowings
The fiscal deficit shows the amount that would need to be borrowed by the government to meet its expenditure.
Expenditure by 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 defence, 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.
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.
Tavaga is everything you need to start saving for your goals, stay on track, and achieve them in time.
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 public sector units, receipts from union territories, and income from licence fees. Receipts is 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
A developing economy like India has been 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 backwards. 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 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 the revenue of the government decreases due to less taxes, and overall spending increases. 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. The 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 of fluctuation) fiscal deficit.
What is the current fiscal deficit of India
The targeted fiscal deficit for the financial year 2019-20 was 3.3 percent of GDP, which has increased by 115 percent in the first eight months. The gap between expenditure and receipts stood at Rs 8.07 lakh-crore ($112 billion) at the end of November.
The gross tax revenue dropped by 2.6 percent in November, 2019, while the expenditure rose 7 percent, owing to weak GST collection and a corporate tax rate cut (announced in September, 2019, as a fiscal stimulus).
Nearly one-third (28 percent) of the government’s revenue is generated through corporate taxation. Hence, the rate cut is estimated to have cost the Centre around Rs 1.45 lakh-crore.
The pall of gloom over the shadow banks after the collapse of a few NBFCs (payment defaults), who would lend to consumers of durables and automobiles, too have weakened consumer spending further as the rest have tightened their purse-strings.
Of course, poor rural consumption is at the root of the slowdown and the fiscal deficit as farmers are driven to suicide because of unsustainable route to earnings and back-breaking debt.
Rating agency Fitch has revised the revenue growth target to 8.3 percent as compared to the government’s projection of 13.2 percent growth. This is mainly because of the corporate tax cuts and weak GST collection. Fitch has also revised the estimated fiscal deficit at 3.6 percent of GDP in FY20 as compared to previous target of 3.4 percent of GDP.
Divestment, as a tool, could help bridge the gap, as letting go of stake in Public Sector Undertakings (PSU) brings in funds and optimises resources, as private players deploy theirs.
The targeted stake-sale of Bharat Petroleum Corporation Limited (BPCL) as part of its divestment, worth Rs 1.05 lakh-crore could be a challenge to pull off, according to Madan Sabnavis, chief economist at Care Ratings.
A fiscal deficit may also be reduced by borrowing from the central bank or raising through government bonds and treasury bills in the capital markets.
The BJP-led NDA government received Rs 67,400 crores in dividends in August, 2019 from RBI. It has sought another capital infusion from RBI as dividends to pare down the fiscal deficit.
A decrease in imports, a trend continuing in December, 2019, in line with dull consumption, will keep the fiscal deficit in check but to a small extent.
Many observers have said it may be counterproductive for the Centre to think of reducing the fiscal deficit as the measures needed for it, such as cutting back on government spending, will only dampen demand-creation further.
In the last few years, the trend in fiscal deficit has been one of a decline. Since 2014, the fiscal deficit has been brought down from 4.1 percent to 3.42 percent in 2019.
Fiscal deficit and revenue deficit
While fiscal deficit is the excess of government spending over its earning, revenue deficit is the gap between the government revenue expenditure and the total revenue receipts, from both tax and non-tax sources.
Fiscal deficit vs budget deficit
A budget deficit describes the difference between current expenditure and current revenue of a government.
Fiscal deficit is preferred as a metric rather than budget deficit in the Indian economy.