What is Fiscal Deficit?
Fiscal Deficit is the gap between the total revenue and expenditure of the government, in a financial year. In short, when the government expenditure exceeds government revenue, it is a fiscal deficit. This reflects the borrowing requirement of the government.
It is an integral part of fiscal policy and thus is inevitable. It occurs due to a rise in capital expenditure. To finance these expenditures, the government raises funds from the capital markets, by issuing bonds or from the central bank. Disinvestment is also a way of financing fiscal deficit.
While a high fiscal deficit results in inflation, currency devaluation and a rise in debt, a low fiscal deficit is a positive sign that indicates a healthy economy.
Components of Fiscal Deficit
- Revenue generated from taxes: It includes income tax, GST, customs duties, excise duties and corporation tax.
- Non-tax revenue: It covers interest received through loan recovery, Receipts of union territories, dividends and profits, external grants and other non-tax revenues.
In the Budget, the government sets aside money for different purposes. This includes payment of salaries and pensions, payment of interest, building ports, highways and schools, and funding projects related to healthcare and public utility.
Calculation of Fiscal Deficit
The government calculates the fiscal deficit both in absolute terms and as a percentage of the country’s gross domestic product (GDP). Mathematically, one can express it as:
Fiscal Deficit = Total Government Revenue (excluding borrowings) – Total Government Expenditure
Here, government revenue includes all money received, while government expenditure includes all money spent, be it capital or revenue.
Alternatively, Fiscal deficit = Budget Expenditure (BE) > Budget Revenue (BR) other than borrowings.
Therefore, the fiscal deficit is equal to the actual borrowings and other liabilities of the government.
Causes of Fiscal Deficit
- Increased Government Spending: The government runs different policy programs, subsidies and initiatives to uplift the marginalized sections of society or to provide aid to farmers. For funding such programs government needs money, which ultimately increases its spending.
- Taxation policies: Taxes are one of the main streams of government revenue. If the government introduces policies that either lower the tax rates or exempt a major section of society from tax burden then the income from taxes will decrease. Resultantly, this will widen the fiscal deficit.
- Economic Downturn: During periods of economic recession, a fall in government revenues is seen, due to decreased economic activity. To overcome this situation, the government announces expansionary fiscal policies like tax cuts, to encourage consumer spending. This adds to the fiscal deficit.
- Natural Calamities or War: Government expenditure tends to surge during crises such as war or natural disasters like floods and earthquakes. This rise is to address these pressing issues and extend financial assistance to the affected population.
- Interest in Debt: When the government borrows funds from different sources, it incurs interest expenses. The interest accrued on debt also forms part of the fiscal deficit.
Effect of Fiscal Deficit
- Borrowing and Interest Costs:
- A fiscal deficit happens when a government spends more money than it earns.
- To cover the gap, the government borrows money, leading to increased debt.
- More borrowing means more interest payments, using up a significant portion of the budget.
- Inflation Risk:
- If the government prints more money to cover the deficit, it can lead to inflation.
- Inflation erodes the purchasing power of money, affecting people’s savings and the overall economy.
- Crowding Out Private Investment:
- High government borrowing can raise interest rates.
- This makes it more expensive for businesses and individuals to borrow money for investments, potentially slowing down economic growth.
- Impact on Exchange Rates:
- Persistent fiscal deficits may lead to a depreciation of the national currency.
- A weaker currency can affect imports, potentially leading to higher prices for goods and services.
- Reduced Fiscal Space:
- Continuous deficits limit the government’s ability to respond to economic downturns or crises.
- With already high debt, there’s less room for fiscal stimulus measures during tough times.
- Confidence and Credibility:
- High and persistent fiscal deficits can erode investor and public confidence in the government’s financial management.
- This may result in higher interest rates and difficulties in raising funds in the future.
- Burden on Future Generations:
- As the government borrows more, it passes the burden of repayment to future generations.
- This can limit the opportunities and resources available to future citizens.
Thus, fiscal deficit plays a significant role in understanding how well the government is managing its money and whether the economy is stable or not. The implications of fiscal deficit include rise in inflation, an increased reliance on foreign countries, falling into a debt trap and a financial burden on future generations.