Understanding the Concept of Fiscal Deficit

01 February 2023
5 min read

‘Fiscal’ means ‘relating to the government’s revenues.’ Whenever you hear this term used in any context, you must understand that the reference is to the government's revenue. Also, ‘Deficit’ means ‘shortage.’  

A fiscal deficit is a difference between a government's total revenue and expenses in a given fiscal year. It indicates the extent to which a government relies on borrowing to finance its spending. A fiscal deficit can be funded by issuing government bonds, increasing taxes, or running down foreign exchange reserves. If a government runs a fiscal deficit for an extended period, it can lead to an accumulation of debt and potentially lead to inflation.

Fiscal Deficit – The Calculation

The calculation of fiscal deficit is simple-

Fiscal Deficit = Government Income – Government Expenditure

This can be expanded for better understanding as follows:

Fiscal Deficit = (Revenue Expenditure + Capital Expenditure) – (Revenue Receipts + Capital Receipts)

Rearranging the terms, we get,

Fiscal Deficit = (Revenue Expenditure – Revenue Receipts) + Capital Expenditure – (Recoveries of loans + other Receipts)

Most economies around the world, including India, run into a fiscal deficit. In other words, the government’s expenditure is more than its income. However, the converse is also possible – Fiscal Surplus. This happens when the government’s income is more than its expenditure. 

It is essential to note that the fiscal deficit does not mean that the country is not economically sound. However, if the government is spending a lot on developmental projects like constructing highways, airports, etc., or industries that will contribute to its income in the coming years, then its current fiscal deficit can be high. Hence, while looking at the fiscal deficit figure, it is essential to analyze the income and expenditure sections carefully too.

What Causes Fiscal Deficit?

A fiscal deficit occurs when a government's total expenses exceed its total revenue. This can happen for a variety of reasons, including-

  • Increased Government Spending

When a government increases spending on programs or initiatives, it can lead to a higher deficit if revenue does not grow at the same rate.

  • Lower Revenue

A decrease in revenue, such as a decline in tax revenues or a reduction in revenue from natural resources, can also contribute to a higher deficit.

  • Economic Downturns

During an economic recession, government revenues may decrease while expenses increase, leading to a higher deficit.

  • War Or Natural Disasters

The costs of war or natural disasters can also contribute to a higher deficit as the government may need to increase spending to address these issues.

  • Social Welfare

A country that has many social welfare programs running and is expensive to run may also cause a higher deficit.

  • Interest On Debt

A government may also have to pay a significant amount of money in interest on its debt, which can also contribute to a higher deficit.

How Does The Government Manage Fiscal Deficit in India?

The government of India manages fiscal deficit through a combination of revenue generation and expenditure control measures. Some of the critical criteria used to manage the fiscal deficit in India include:

  • Taxation

The government increases taxes on various goods and services to increase revenue. This helps to reduce the fiscal deficit by bringing more money into the government's coffers.

  • Expenditure Control

The government also reduces expenditure on various schemes and programs to control the fiscal deficit. For example, this may involve cutting back on subsidies and reducing the number of government employees.

  • Public-Private Partnerships

The government also encourages public-private partnerships to increase revenue and reduce expenditure. This can involve private companies investing in infrastructure projects or taking over the management of public services.

  • Borrowing

The government also borrows money from domestic and international sources to finance its expenditure. However, this should be done sustainably to avoid creating a debt trap.

  • Disinvestment

The government also disinvests or sells its stake in public sector enterprises to raise money. This can be done through strategic sales or listing these companies on the stock market.

  • Monetary Policy

The Reserve Bank of India also plays a role in managing fiscal deficits by controlling the supply of money in the economy. This helps to control inflation and keep interest rates low, which can help to reduce the fiscal deficit.

Overall, the government uses a combination of these measures to manage the fiscal deficit in India. However, it is essential to note that a sustainable and balanced approach is necessary to avoid creating a debt trap.

Ideal Fiscal Deficit in India

The ideal fiscal deficit in India is a topic of much debate among economists and policymakers. Fiscal deficit refers to the difference between the government's total revenue and its total expenditure. In other words, it is the amount by which the government's spending exceeds its income.

In India, the fiscal deficit has been a significant concern for many years. The country has one of the highest budgetary deficits in the world, which has led to fears of inflation, debt, and economic growth.

There are different views on the ideal fiscal deficit in India. Some experts argue that a high fiscal deficit is necessary to stimulate economic growth and create jobs. However, others say that a high fiscal deficit is unsustainable in the long term and can lead to inflation and debt.

One view is that the ideal fiscal deficit in India should be around 3% of the country's GDP. This is the level that is recommended by the International Monetary Fund (IMF) and is considered to be sustainable in the long term.

Another view is that the ideal fiscal deficit in India should be higher, around 5% of GDP. This is because India is a developing country with a large population and a high poverty rate. Therefore, a higher fiscal deficit is necessary to fund social welfare programs and infrastructure projects to reduce poverty and improve the standard of living for all citizens.

The ideal fiscal deficit in India is a complex issue with no clear-cut answer. It depends on various factors, such as economic growth, inflation, debt, and social welfare programs. Therefore, a balance must be struck between stimulating economic growth and maintaining fiscal sustainability in the long term.

Conclusion

In conclusion, the fiscal deficit in India continues to be a major concern for policymakers and economists. Despite efforts to reduce the deficit, it remains high and continues to pose challenges for the Indian economy.

Factors such as increasing government spending, low tax revenues, and slow economic growth have all contributed to the high deficit. Therefore, the government must increase revenue through tax reform and increased financial investments to address this issue. 

Additionally, efforts must be made to reduce unnecessary spending and prioritize essential public services. Only by taking a comprehensive approach to addressing the fiscal deficit can India achieve sustainable economic growth and stability in the long term.

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