Investment and Fiscal Deficits | Gist of Rajya Sabha TV / RSTV (now Sansad TV) - UPSC PDF Download

Introduction:

United Nations ‘World Economic Situation and Prospects 2022’ report has stated that India’s economic recovery is on a solid path. The UN report credited the vaccination drive, less stringent social restrictions, and supportive monetary stances as reasons for this growth adding that encouraging private investment will remain crucial to stay on the recovery path. Government has implemented several major reforms in recent years to boost investment and GDP growth. Various measures to support broad-based and inclusive economic development were announced in Union Budget 2021-22 followed by a relief package in June 2021 to strengthen public health and provide impetus for growth and employment measures. On the fiscal deficit front the rating agency ICRA in its recent report says that though government’s gross tax receipts is expected to overshoot the budgeted amount, the shortfall in disinvestment target this year may lead to a fiscal deficit of around 7 per cent of the GDP.

Fiscal Deficit is a term used to denote a deficit in government earnings during a financial year. A fiscal deficit occurs when the total expenditure of the government exceeds the total revenue (excluding borrowed funds). Fiscal deficit is “reflective of the total borrowing requirements of Government”.

Fiscal Deficit:

• The difference between total revenue and total expenditure of the government is termed as fiscal deficit.
• It is an indication of the total borrowings needed by the 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.

Significance of fiscal deficit:

• In the economy, there is a limited pool of investible savings. These savings are used by financial institutions like banks to lend to private businesses (both big and small) and the governments (Centre and state).
• If the fiscal deficit ratio is too high, it implies that there is a lesser amount of money left in the market for private entrepreneurs and businesses to borrow.
• Lesser amount of this money, in turn, leads to higher rates of interest charged on such lending.
• So, simply put, a higher fiscal deficit means higher borrowing by the government, which, in turn, mean higher interest rates in the economy.
• A high fiscal deficit and higher interest rates would also mean that the efforts of the Reserve Bank of India to reduce interest rates are undone.

What is the acceptable level of fiscal deficit for a developing economy?

• Here, governments also have to invest in both social and physical infrastructure upfront without having adequate avenues for raising revenues.
• In India, the FRBM Act suggests bringing the fiscal deficit down to about 3 percent of the GDP is the ideal target. Unfortunately, successive governments have not been able to achieve this target.

Impacts of Fiscal Deficit:

• It can mean that the Government is spending money on unproductive programmes which do not increase economic productivity. (For example MNREGA, most of the money is eaten midway by the Sarpanch and Local officers.)
• As government borrows from RBI which meets this demand by printing of more currency notes (called deficit financing), it results in circulation of more money. This may cause inflationary pressure in the economy.
• When Government keeps borrowing and borrowing to fill up the fiscal deficit pothole, then bond yield will increase. It is not good because more and more of taxpayers’ money (i.e. Government ‘s incoming money) will go in repaying that bond interest rate rather than going into education or healthcare.
• Government may be compelled to borrow to finance even interest payment leading to emergence of a vicious circle and debt trap.
• Fiscal deficit “Crowds out” investment from private sector as Government borrows most of the cash.
• Borrowing is in fact financial burden on future generation to pay loan and interest amount which retards growth of economy.

Strategies to Reduce Fiscal Deficit:

• There is a need to implement NK Singh committee recommendations with respect to Fiscal deficit for a stable economy.
  • Suggested a fiscal deviation band of 0.5%.
  • This means that the government can deviate by 0.5% from the fiscal Deficit target if the economy is in slowdown.
  • The flexibility has been allowed for the government to create space for stimulus to pump-prime the economy.
• On the other hand, when the economy is doing well, the deficit can be compressed by 0.5%.
• 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.
• A drastic reduction in expenditure on major subsidies. Reduction in expenditure on bonus, LTC, leaves encashment, etc. Austerity steps to curtail non-plan expenditure.
• Tax base should be broadened and concessions and reduction in taxes should be curtailed. Tax evasion should be effectively checked. More emphasis on direct taxes to increase revenue. Restructuring and sale of shares in public sector units.
• Famous economist John Maynard Keynes opined that deficits actually assist nations in climbing out of economic recessions.
• However, fiscal conservatives believe that deficits should be avoided by the government which should be inclined towards a balanced budget policy.

Conclusion: