Fiscal Deficit: Is It Really Bad For The Economy?

No matter how scarce revenue collection is, the Government must loosen its purse strings to uplift the country. When it spends more than it earns, a fiscal deficit arises. But is it that bad?

The first day of the second month of every year is long-awaited. Wondering what's the reason? Naturally, the budget presentation. Every year, on 1 February, the central government presents India's Union Budget. For 2024, an Interim Budget was presented. You can read about the highlights of the 2024 budget.

Besides others, this budget mainly entails three terms: public revenue, public expenditure, and fiscal deficit. The first two terms are pretty self-explanatory. However, the third one is an important concept to understand.

So today, let's dive into the topic of fiscal deficit and clarify any misconceptions that you might have.

What is a Fiscal Deficit?

The government describes the fiscal deficit of India as "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".

In layman's terms, a fiscal deficit means a shortfall of public or government revenue with respect to expenditures. You see, for every fiscal year, the government decides on a fixed revenue capital, and the extra amount utilised from the funds predecided is known as fiscal deficit. It is pretty familiar to you spending more than your monthly or yearly budget.

The fiscal deficit, in general practice, is disclosed as a percentage of Gross Domestic Product (GDP).

How to Calculate Fiscal Deficit?

The fiscal deficit is calculated by subtracting the total expenditure of the Government from the total revenue:

Fiscal deficit = Total expenditure - Total receipts excluding borrowings

Okay, but why exclude borrowings, you ask? Well, though borrowing is a receipt, it is not a source of revenue that is earned. It is more of a liability that needs repayment. Therefore, to determine an accurate rate of fiscal deficit, borrowings are excluded from the public revenue.

Revenues and Expenditures of the Government

As fiscal deficit revolves around the revenue generated and the amount expended by the Government, it's important to understand these concepts better.

Government revenue can be broadly classified as tax revenue and non-tax revenue. Tax is the primary source of revenue for the Government. Various taxes paid by citizens of a country, like income tax, corporate taxes, wealth tax, CGST, SGST, IGST, etc., form a major chunk of the revenue that a government generates. Non-tax revenue streams include fines and penalties, royalties and external grants received, dividends and profits of public sector entities, interest income received on loans extended, etc.

Public expenditure can be classified on various bases, but areas of expenditure majorly include the amount expended towards social welfare like healthcare, education, infrastructure, development of backward areas and the underprivileged, national defence, interest payments on bonds and other securities, etc.

Is a Fiscal Deficit Always Bad?

On an individual level, if expenditure exceeds the income generated, it is not considered efficient management of one's personal finances. However, on a national level, this principle does not hold true.

Public expenditure is first estimated, based on which the streams of revenue are decided upon. This leads to a fiscal deficit in most cases. This might tempt most of us to think that a country with some fiscal deficit is underperforming! But that's not true.

The fiscal deficit is not really bad. As long as public expenditure is incurred towards the creation of productive assets like roads, ports, bridges, etc., a fiscal deficit would indirectly help boost economic development.

However, this does not mean that the fiscal deficit of a country can continue to increase. Borrowing for the sake of managing the deficit can have long-term implications. There are ways that a government can set off borrowings. It can reduce its expenditure or print currencies to increase the money supply. However, steps like printing excess currencies can lead to inflation, which might not be feasible for the country's economic condition.

Theoretically, a fiscal deficit of around 5% is considered safe. However, the limit of a safe or ideal fiscal deficit varies from one country to another based on a large variety of factors.

How to Correct a Fiscal Deficit?

As mentioned above, the fiscal deficit is not necessarily bad. But sometimes, it needs to be corrected. It can be corrected either by reducing the planned expenditure or by increasing the taxes and other revenue streams. Deficit financing is a practice by which a country acquires funds to manage its fiscal deficit.

Issuing government securities like T-bills and government bonds through open market operations (OPO) is another way that is generally adopted. Securities are liabilities that need to be repaid.

One downside of issuing securities is that it reduces the potential capital stock of the country; as these are safer avenues for investments, individuals might prefer investing in government securities rather than in public companies. Companies and other businesses usually try to prevent this by declaring a higher interest than the government securities.

In other words, the total borrowings of the government can be equated to this fiscal deficit.

In instances when the government is neither able to improve its revenue generation through taxes nor able to reduce the lines of expenditure, it resorts to the practice of disinvestment. It tends to disinvest from the profit-making public sector units. Many experts in the field believe that this is not an efficient practice, as it leads to the government losing the share of profits that these units generate.

The Bottom Line

The fiscal deficit of a country is a major criterion for determining the soundness of the economy. It is crucial to maintain the deficit along the safe border; otherwise, the country might have to face long-term repercussions.

India has managed not to deviate much from the ideal limit in the past decade. But the pandemic changed the status quo. While the budgeted fiscal deficit was around 3.5% of the GDP, in reality, it came out to be almost thrice ~ 9.3%!

Apparently, the fiscal deficit for 2024-25 is estimated to be 5.1% of GDP! Let's just hope that the government's wish to reduce it to 4.5% by 2025-26 will be achieved as planned.

Anyway, what do you think? How much of a fiscal deficit is too much? Tell us in the comments below.