The Hindu Editorial Analysis- 7th September 2024 | Current Affairs & Hindu Analysis: Daily, Weekly & Monthly - UPSC PDF Download

Stick to Fiscal deficit as the norm for fiscal prudence

Why in News?

Government expenditures exceeding revenue by a high margin can lead to a difficult situation. In the 1980s, rising fiscal deficit accompanied by rising government debt led to a difficult balance of payments situation and a high ratio of interest payment to revenue receipts. This forced the government to borrow progressively more to meet developmental expenditures.

What is Fiscal Deficit? 

•  A fiscal deficit happens when a government's total income is less than its total spending in a year. 
•  This situation can arise if a government spends more than it earns or if its income does not cover its expenses. 
•  Governments often incur a fiscal deficit to fund important investments in areas like infrastructure, education, and healthcare. 

Background of Fiscal Deficit in India

• India has a long history of fiscal deficits.
• After gaining independence, the government had large fiscal deficits to support its ambitious development plans.
• In the 1980s and 1990s, the fiscal deficit increased due to several factors, such as:
  • The global oil crisis.
  • The Gulf War.
  • Domestic economic reforms.
• In the early 2000s, the fiscal deficit started to decrease because of strong economic growth and efforts to improve financial management.
• However, the global financial crisis in 2008 caused the fiscal deficit to rise again.
• Recently, India's fiscal deficit has been going down once more, yet it is still relatively high compared to other countries.

Calculation of Fiscal Deficit

• The formula for calculating fiscal deficit is:
  • Fiscal Deficit = Total Expenditure – Total Receipts (excluding borrowings)
• Total Expenditure includes:
  • Revenue expenditure
  • Capital expenditure
• Total Receipts consist of:
  • Revenue receipts
  • Loan recoveries
  • Capital receipts
• Fiscal deficit is shown as a percentage of GDP. For instance, a fiscal deficit of 6% means the government needs 6% of the GDP to cover its spending.
• A fiscal deficit below 4% is generally seen as healthy for the economy.
• If the fiscal deficit is more than 4%, it is important to take steps to either boost revenue or limit spending.

Components of Fiscal Deficit

• Revenue/Income: This is the total money that the government makes in a financial year. More revenue helps keep the fiscal deficit at a healthy level. The Economic Survey 2021-22 indicates that the Net Tax Revenue increased by 64.9% compared to the previous year from April to November 2021. This includes both Direct Taxes and Indirect Taxes. The revenue is divided into two categories:
  • Tax Revenue: This includes revenue from various taxes such as:
    • Goods and Services Tax
    • Corporate Tax
    • Customs Duty
  • Non-Tax Revenue: This includes money from:
    • Fees
    • Penalties
    • Interest Receipts
    • Profits and Dividends
• Expenditure: This is the total amount the government spends in a financial year. It is important to manage expenditure to ensure the financial health of the country. While higher spending can lead to a larger fiscal deficit, it can also support economic growth. A fiscal deficit of 4% is generally seen as a good balance for additional spending. The Economic Survey 2021-22 shows that government expenditure increased by 8.8% year-on-year for the period from April to November 2021. The expenditure is categorized into:
  • Revenue Expenditure
  • Capital Expenditure
  • Interest Payments
  • Grants for Creating Capital Assets

How is Fiscal Deficit Financed?

• The fiscal deficit is mainly financed through two sources: Borrowing and Deficit Financing.
• Borrowings can be categorized as:
  • Internal Borrowings: Loans taken from commercial banks.
  • External Borrowings: Loans from outside sources like the IMF, other global financial institutions, or other governments.
• Deficit Financing: The government can borrow money from the Reserve Bank of India (RBI) and offer its securities to the RBI. In this case, the RBI prints new money to cover the government's deficit, a process known as Monetization of the Deficit.
• Borrowing is crucial for funding the fiscal deficit, and it can come from the market or the RBI. However, financing the deficit can lead to:
  • Inflation: Deficit financing can cause inflation because it increases the money supply in the economy.
  • Debt: This approach raises the government's overall debt.
  • Crowding Out: Increased government borrowing can limit the money available for private sector investments, potentially pushing private companies out of the market.

Importance of Fiscal Deficit for the Economy

• Stimulates Economic Growth:
  • When the government spends more than it earns, it puts more money into the economy.
  • This extra money allows consumers and businesses to buy more goods and services.
  • As people spend more, it can lead to an increase in economic growth.
• Helps Stabilize the Economy During Downturns:
  • In tough economic times, there is often less demand for goods and services.
  • This drop in demand can cause a recession, which means less production, more unemployment, and falling prices.
  • The government can respond to these challenges by increasing spending or lowering taxes.
  • This approach can help raise demand again and support the economy during hard times. 
• Benefits of Fiscal Deficit
  • Boost economic growth: Fiscal deficits can help fund government projects in areas like infrastructure, education, and healthcare. These projects can improve productivity and lead to economic growth. 
  • Create jobs: When the government spends money, it can directly create jobs in the public sector and also help create jobs in the private sector. 
  • Lower poverty and inequality: Government spending on social programs can assist in reducing poverty and narrowing the gap between different income groups. 
  • Stabilize the economy: Fiscal deficits can be used to help balance out the negative impacts during economic downturns. 
• Drawbacks of Fiscal Deficit
  • Inflation: If the government spends more than it earns, it might need to print more money to cover its expenses. This can cause inflation, as there will be more money available for the same amount of goods and services. 
  • High interest rates: A significant fiscal deficit can lead to increased interest rates. This happens because the government competes with private businesses for loans. Higher interest rates can make it costlier for businesses to invest, which can slow economic growth. 
  • Crowding out: Fiscal deficits can limit private investment. The government competes with private entities for resources. When it borrows money, it can take funds away from private businesses, making it tougher for them to invest. 
  • Debt trap: If a government accumulates too much debt, it risks falling into a debt trap. This situation occurs when the government must borrow even more money just to pay off its existing debt, leading to a continuous cycle of increasing debt. 

Difference between Fiscal Deficit and Revenue Deficit

The table below highlights the difference between fiscal deficit and revenue deficit:

Conclusion

• Fiscal Management is a crucial duty of the government.
• The growth and development of a specific area in society require spending.
• This increase in spending can result in a Fiscal Deficit.
• The government covers its deficit through capital borrowings from various sources.
• Additionally, the government raises funds by collecting taxes.

UPSC Previous Mains Year Questions on Fiscal Deficit

Differentiate between ‘Revenue Deficit’ and ‘Fiscal Deficit.’ What are the successes and failures of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003?