FISCAL DEFICIT

Nandini Ramchandani (M2021LSP012)

K Sridhar (M2021LSP009)
N S Rondabu (M2021LSP015)
Aman Bhushan (M2021LSP004)
Rohan Deore (M2021LSP021)
Aditya Raj (M2021LSP003)

Centre of Labour Studies and Practices

A report submitted in partial fulfillment of the requirements for

the course
GL 02 : Elements of Macroeconomics

Under the Guidance of

Prof. Samapti Guha
 Introduction

The fiscal balance is determined by the government's revenue versus its

expenditure in a given fiscal year. The difference is the fiscal deficit, which
occurs when the government's expenditures exceed its revenue in a given year.
The fiscal deficit is measured in both absolute terms and as a percentage of the
country's GDP.
A country's fiscal deficit is measured as a percentage of GDP or simply as the
amount of money spent by the government over its revenue. In either case, the
income figure only includes taxes and other revenues, not money borrowed to
make up the difference.
The fiscal deficit, in mathematical terms, is written as[total revenue generated
— total expenditure]. The total revenue is the sum of revenue receipts, recovery
of loans, and other government receipts.
While the majority of countries continue to project deficits, surpluses are a rare
occurrence. A high deficit can also occur when the government spends on
development projects such as highways, ports, roads, and airports, eventually
generating revenue for the government.

The fiscal deficit is calculated using two factors: income and expenditure.

The income component comprises two variables: revenue generated by taxes

levied by the Centre and income generated by non-tax variables. The amount
collected from corporation tax, income tax, customs duties, excise duties, and
GST, among other things, is taxable income. Meanwhile, non-taxable income
comes from various sources, including external grants, interest, dividends, and
profits, and receipts from Union Territories, to name a few.
Expenditure component: The government allocates funds in its Budget for
various purposes, including paying salaries, pensions, and emoluments, creating
assets, and funding infrastructure, development, and health care, among other
things.

Further, the budget deficit (excess of expenditure over revenues) is divided into
three types, namely:-
1. The revenue deficit is the difference between total revenue
expenditures and total revenue receipts for the government. It only
cares about the government's revenue receipts and expenditures.
Revenue deficit = Total Revenue expenditure – Total Revenue receipts.

2. A fiscal deficit is an excess of total budget expenditure over total

budget receipts excluding borrowings during a fiscal year.
Fiscal deficit = Total expenditure – Total receipts excluding borrowings

3. The primary deficit is the current year's fiscal deficit minus interest
payments on previous borrowings. In other words, whereas fiscal
deficit refers to borrowing needs that include interest payments,
primary deficit refers to borrowing needs that do not include
interest payments (i.e., amount of loan).
Primary deficit = Fiscal deficit – Interest payments.
In other words, if one adds borrowings by the governments to revenue receipt,
then the deficit will decrease, which is called revenue deficit. A primary deficit
is a difference between the fiscal deficit of the current year and the interest paid
by the government on loans obtained in the Past. So, while calculating this form
of the deficit, we do not consider the interests paid, so here again, the deficit
will decrease because expenditure is decreasing. The deficit will depend on
expenditure and revenue, as explained above.

Causes of fiscal deficit

The leading cause of the rise of fiscal deficit is the payment of interest of the
previous loans. In the case of India, the interest payment roughly takes around
28% of all government expenditure. The other factor that also caused the rise in
fiscal deficit is the lousy performance of various government Public sector
undertakings. Due to inefficiency or lousy management, PSU often needs
government bail-out packages to survive, which act as an extra burden to the
government. Tax income is the prime source of Government income so, the
evasion of tax acts as less money in
the government hand to spend since some expenditure can not be ignored, so it
puts a burden on the government to raise more funds. That acts in a rise in the
fiscal deficit. An increase in subsidies also acts as an expenditure of income that
is not fruitful if the target of the
subsidies does not match up. Similar to subsidies, the defense expenditure is
also not a substantial capital expenditure as these are main assets that do not
give monetary benefits.

Consequences of Fiscal Deficit

There are various consequences of the rise of fiscal deficit as it leads to some
debt trap that somehow influences the nation's sovereignty. The high fiscal
deficit leads to cost-cutting in the Budget, which ultimately influences the
capital expenditure and less social protection benefits. Since the government
needs funds for interest payments, it drives banks; funds to pay the interest
payments. So, the bank has less liquidity to offer to the public, leading to a rise
in the bank's interest
rate. Due to this, the price of the commodity rises as it leads to cost pull
inflation. The high fiscal deficit also discourages foreign investment in the
country.

Trend Analysis

(Source: Data as per RBI records)

The above graph helps us to understand the trend of fiscal deficit in our country.
In the above graph, we can see the fiscal deficit was considerable during 2008-
10. A global recession is usually considered the reason for the increasing
trend. During a recession with high unemployment and low income, the fiscal
deficit effectively ends this trend. In order to revive the economy, the
government spends more than its revenue so that income and employment levels
in the economy will improve. So, in that case, expenditure increased, so the
deficit also increased. Again, during 2010-11 the fiscal deficit has decreased
mainly because of higher economic growth. During 2011-12, again the deficit
increased than the usual trend. Here, the revenue side was more responsible than
the expenditure part. As per a few sources, the increase was due to lesser tax
collection, slippage in the PSU divestment program. Post-2011-12, the graph
more or less followed a decreasing trend. Even though a few events like a
change of government, financial policies (new tax policies, demonetization),
affected both government expenditure and receipts, the overall fiscal deficit did
not vary much till covid-19 affected the economy.
The impact of Demonetization on Fiscal deficit and fiscal policy can be
summarized by these points:-

1. Less liquidity / less cash flow.

2. Lowered inflation.

3. Lowered growth rate.

4. Increase in Tax burden.

As the deficit spending was minimised to around 3 per cent of GDP after post
demonisation. The government attempted to boost the less cash flow and
lowered inflation by increasing the tax burden. Despite the attempt, the growth
rate had a steep fall for from 2016 to 2021.

Due to covid-19 economic activities were a form of taxes, and on the other
hand, government expenditure was also increased. Both combinations lead to
the increase of fiscal deficit, which will be discussed more in detail below.
Government expenditures usually consist of salaries, pay and allowances
pensions, for interest payments (this forms a significant share in fiscal deficit
every year), subsidies, defense expenses, non -defense expenditures are of 9%
and other expenditures which depend on the need and it may be unique for that
financial year. All the expenses mentioned above can be broadly classified into
capital and revenue expenditures, previously called development and non-
development expenditures. Capital expenditure consists of all the expenditures
by the government that can further lead to economic growth and development.
These involve expenditures in the production of capital goods and services that
provide instant benefits and have some future prospective benefits. These
expenditures include spending on various economic services. Revenue
expenditures are like consumption expenditure and provide instant benefit and
expand the well-being of the society, but it does not lead to further economic
growth or development. These expenditures include expenditure on subsidies,
defense expenditure, pensions, etc. So, it is difficult to draw a unique
relationship between fiscal deficit and other variables, like inflation,
unemployment. It is difficult to say that inflation will also increase if the fiscal
deficit increases or the other decreases if one increases. The relation between
fiscal deficit and inflation is a highly debated issue in the field of economics. It
is difficult to draw a general universal trend, but considering the usual
expenditures of any country, a relation can be developed which will be restricted
to that developing country.
Empirical studies do not provide a strong relationship between inflation and
employment, implying the breakdown of the Philips curve. If we try to
understand in simple terms, if fiscal deficit comes from capital expenditure that
involves investment in economic development, increasing pools of goods and
services, in that case, employment will also increase. If a significant portion of
the deficit comes from revenue expenditure on unproductive investments like
interest payments in the economy, then there will not be any significant increase
in the economy's productive capacity. To consider a context here, let us consider
the case of 2018-19 where interest payments were about 24%, and some amount
money was spent for welfare activities, and only 12% of the expenditure was for
capital spending in Financial Year 18. if you are providing money to people but
are not increasing the pool of goods and services that they can avail from, then
it may increase the inflation.
 Fiscal Deficit and Fiscal Measures

A fiscal deficit directly impacts a country's growth rate, price, inflation,

aggregate supply, and demand. Budgetary deficit is usually financed by
borrowing from private enterprises, banks, and overseas investors. When an
economy is in a slowdown government tends to run a higher debt to counter the
harmful pact of slow down in the private market. If the size of the deficit is not
managed with a diligent policy, it could lead to inflation. The implications of
fiscal deficit are high inflation, heavy foreign dependency, huge government
borrowing debts leading to a debt trap because of high-interest payments by the
government. A reduction can reduce the fiscal deficit in public expenditures by
reducing subsidies and minimising non-plan expenditures. Increasing the tax
burden and profitability of public sectors undertakings and controlling tax
evasion are the standard measures used by the government in reducing the fiscal
deficit.
 Fiscal Deficit and Growth

Is Fiscal deficit a boon or ban? Considering all aspects of fiscal deficit its
sounds harmful. However, the deficit is not necessarily dangerous usually;
deficit spending can help developing countries develop assets and infrastructure
that will generate revenue in the long run. Deficit spending is also a helpful way
to boost a stalled economy. Whether a fiscal deficit contributes negatively or
positively to an economy depends much on the fiscal policy and less on the size
of the fiscal deficit. The fiscal deficit can be minimized with policy lapses,
resulting in an unfavorable growth rate.

Understanding the Present Through Revisiting Past

India has sustained high gross fiscal deficits, which persisted through both low
and high growth phases through the past four decades.

1940 – mid-1975 Period – There was a planned development strategy, with

collective decision through public sector-driven industrialization. The fiscal
deficit was under control approx 3.5% of GDP.

Late 1970 to 1990 period – It was a phase marked with post-1971 war impacts,
emergency period, rising oil price, protectionist approach, unplanned revenue
expenditure for populist schemes leading to systemic inefficiencies and low
economic growth. This all leads to a further rise in the fiscal deficit.

1991 LPG reforms – Tax reform aimed to increase the relative share of direct
taxes, decrease the share of trade taxes, and decrease the share of subsidies.
Disinvestment measures were accepted, which increased capital receipt.
Minimum government and maximum governance principles were emphasized.
It reduced the fiscal deficit in the short run but did not yield long-term effects
due to a lack of consensus with the rise of coalition politics.

However, in the 2000s, the Fiscal deficit resurfaced with the focus of
competitive populism towards economic populism to capture power. Thus the
(FRBM) Fiscal Responsibility Budget Management Act was passed in 2002 to
keep the fiscal deficit under the limit of 3% of GDP by March 2021, with a
deviation of 0.5% exceeding value tolerable. Also, there was a limit of not
exceeding general government debt and central government debt not exceeding
60% and 40% of GDP respectively by 2024-2025. Even the target was not met
during the shocks of the subprime crisis, and the fiscal deficit went to an all-
time high of 10.6% for GDP. During this period, the government adopted
counter-cyclical expansionary fiscal measures (fiscal stimulus) to increase the
liquidity in the economy.

There was a steep rise in the fiscal deficit from 3.4 % of GDP in 2018-2019 to
4.6% of GDP in the financial year 2019-2020. This skyrocketed further in the
financial year 2020-2021. The finance minister announced the fiscal deficit of
9.5 % of GDP during the budget session.

The nationwide lockdown played a massive role in this spike. A significant part
of the working population went jobless, which had an adverse effect on tax
collection. The informal sector was also severely hit due to the lockdown. To
tackle this, the government announced a covid relief package amid the
pandemic to help people.

The FRBM Act was amended recently because supply and demand shock
resulted from the covid19 crisis with changing fiscal deficit limit up to 4.5% of
GDP by 2025-2026 and additional limit of 0.5% on state fiscal deficit. With the
fiscal stimulus through Atmanirbhar Bharat schemes and other emergency relief
measures to boost the economy's liquidity. The fiscal deficit in the financial year
2020-2021 was approx 9.3% of GDP.

Inference

Additional public revenue from increased tax collection may lead to a higher
fiscal deficit if public expenditure exceeds the collection of tax revenue from
high growth. Thus, India has sustained high levels of fiscal deficits, which
persisted through both low and high growth phases through the past four
decades.
 Conclusion

There is a need for systems and institutions to ensure checks and balances to
limit the extent of welfare programs as a part of the party's political agenda. A
steep rise in debt has to be avoided, which can disrupt the pace of growth. As
recommended by N.K.Singh Committee needs to constitute an independent
fiscal council to promote stable and sustainable public finances through
periodically reviewing, monitoring, and evaluating fiscal policies. It could
enhance transparency, public awareness, and accountability of Budgetary Data,
with discouraging populist shift of government expenditure.