In India, February is the time of the year when the Government announces the annual budget for the country. A country’s budget includes a lot of things that may not be applicable to retail investors.
However, as a responsible investor, understanding the crucial aspects of the budget is important to know the direction in which the economy is expected to move and the industries/sectors that can perform better in the future.
Of all the economic terms and jargon being used to assess the effectiveness of the budget, one term that you will hear frequently is Fiscal Deficit. Today, we will try to decode this term and help you understand the concept of fiscal deficit.
Fiscal Deficit – The definition
The term ‘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 revenue of the government. Also, ‘Deficit’ means ‘shortage’.
Hence, Fiscal Deficit is defined as:
The difference between what a government spends by way of its expenditure and what it collects by way of revenue during a financial year.
Before you listen to the Union Budget 2021, presented by Finance Minister Nirmala Sitharaman on February 01, 2021, if you understand the fiscal deficit and how the government manages it, then you would be able to analyze the announcements better.
Since fiscal deficit is the difference between revenue and expenditure of the government, let’s look at what constitutes the revenue of a country’s government and what its expenditures are.
Revenue of a Government
For a government, the primary source of revenue is taxes. This includes income tax, corporate tax, GST, and other taxes and duties levied from time to time. Additionally, there are some non-tax-based sources of revenue like interest income, dividends, and disinvestment receipts. There can also be more sources of revenue from time to time.
Expenditure of a Government
The government of a country has several expenses to manage like capital expenditure, revenue payments, interest payments, etc.
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 in a fiscal deficit. In other words, the government’s expenditure is more than its income. 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. 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 important to analyze the income and expenditure sections carefully too.
What causes Fiscal Deficit?
The fiscal deficit of a country is the result of:
- Revenue shortfall
- Increase in the government’s expenditure
In a country, the government has to take care of a lot of aspects. Hence, there are times when it has to spend more for the benefit of a certain section of society. This can lead to an increase in expenditure. In fact, a fiscal deficit due to increased spending on infrastructure, employment generation, and the economic development of the country. Usually, a fiscal deficit of less than four percent of the GDP is considered healthy for the Indian economy.
Ideal Fiscal Deficit – India
As a practice, the fiscal deficit is represented as a percentage of the country’s Gross Domestic Product (GDP). The fiscal deficit is expected to be around 7.5% of its GDP in the financial year 2021. Here is a look at India’s fiscal deficit figures over time:
|Year||Fiscal Deficit India (% of GDP)|
As mentioned above, in a developing country like India, a fiscal deficit of 3/4% is considered to be good for the economy. As you can see in the table above, the government has tried to maintain the fiscal deficit within this range. The government tries to maintain this deficit without compromising on the economic growth of the country.
In 2020, the pandemic and subsequent lockdowns led to an economic slowdown impacting its revenue. While the government had estimated a fiscal deficit of around 3.5% of the GDP, experts expect it to be around 7.5% in the current fiscal. With businesses shut and stimulus packages extended to help people survive the lockdown, the upcoming budget might have measures regarding higher tax collections and will shed some light on the government’s Fiscal policy.
How Does The Government Manage Fiscal Deficit?
Since there is a deficit or a shortfall, the government needs to arrange funds to meet the expenditure. In India, the government manages its deficit by borrowing from various sources like the Reserve Bank of India, public sector banks, large public institutions, overseas markets, capital markets, and it can raise funds from the public as well.
Budget 2021 And Fiscal Deficit Targets
The pandemic and its economic impact were unprecedented. Hence, to manage the fallout, many experts believe that the Indian government might have to resort to unprecedented measures to manage the fiscal deficit too. According to the Confederation of Indian Industry (CII), the government can try to consider managing fiscal deficit with a three-year deficit with an immediate stimulus for growth. The CII also recommended that it might be prudent to adopt a flexible target that is range-bound instead of a fixed number. While some experts believe that a fiscal deficit target of around 4-4.5% can be expected, others are recommending different strategies to get the economy back on track. Nonetheless, the entire country will be glued to their screens when the Finance Minister announces the Union Budget 2021 to see how the government decides to tackle this situation.