FISCAL DEFICIT OF THE

GOVERNMENT & ITS IMPACT

ON THE BORROWING RATES
FIS End Term Project Report

Term 4
Aayush Jain (2021PGP126)
Aishwarya Gulabani (2021PGP129)
Akriti Kulshrestha (2021PGP069)
Sahil Bhagtani (2021PGP041)
Sharad Agarwala (2021PGP120)
Tanvi Modi (2021PGP244)
W HAT IS F ISCAL D EFICIT :

Fiscal Deficit describes the gap between the government's total revenue and total outlays. It serves
as a gauge for the total amount of borrowings the government will require. Borrowings are not
considered when determining the total revenue.

The excess of total expenditures, including loans net of recovery, over revenue revenues (including
outside grants) and non-debt capital receipts is known as the Gross Fiscal Deficit (GFD). The gross
fiscal deficit is subtracted from the central government's net loan to arrive at the Net Fiscal Deficit
(NFD).

In most cases, a Fiscal Deficit results from either a reduction in revenue or a significant increase in
capital expenditures. To establish long-term assets like factories, buildings, and other developments,
capital expenditures are made. A deficit is often funded by borrowing from the nation's central bank
or by raising funds on the capital markets by issuing various securities like treasury bills and bonds.

FORMULAE:

There are various forms and interpretations of a Fiscal Deficit. There are several methods of
calculating the same using various and exact measures. The highly practiced conventions are as
follows:

i. Total expenditure - Total receipts (excluding borrowings)

ii. (Revenue expenditure + Capital expenditure) - (Revenue receipts + Capital receipts excluding
borrowings)
iii. (Revenue expenditure - Revenue receipts) + (Capital expenditure - Capital receipts excluding
borrowings)
iv. Revenue deficit + (Capital expenditure - Capital receipts excluding borrowings)
v. Borrowings

Fiscal deficit serves as an indicator of how well the government is managing its finances.

COMPONENTS:

There are two components to Fiscal Deficit. They are follows:

i. Income:
a. Tax revenue: GST, customs duties, corporate tax, etc.
b. Non-tax revenue: dividends and profits, interest receipts, etc.

ii. Expenditure:
This includes capital expenditure, revenue expenditure, grants for capital assets creation,
interest payments, etc.

HOW IS IT FINANCED:

There are primarily two ways of sourcing the fiscal deficit finance. They are follows:
 i. Borrowings: Internally from a commercial bank, or from external sources like the IMF, other
governments, etc.

ii. Printing New Currency: This includes borrowing funds from RBI against its securities (so, RBI
prints new currency)

The government meets the fiscal deficit by borrowing so, it can be said that the total borrowing
requirements of a government in a year is equal to the fiscal deficit of that year.

INDIA’S FISCAL POLICY FRAMEWORK:

The most interesting fact concerning India's fiscal policy agenda is as follows:

 Every five years, a Finance Commission (FC) is required to be established by the Indian
Constitution

 This will serve as the foundation for allocating a share of the centre’s revenues to the state
governments and provide medium-term guidance on fiscal issues, as the states' taxing
power may not always be appropriate to their spending obligations

 Fiscal policy also includes the Union Budget, which the government must present to the
Parliament for approval and discussion of its planned taxing and spending measures

 The 2003 Fiscal Responsibility and Budget Management Act (FRBM) is a law that addresses
financial restraint

FRBM Act, 2003

WHY WAS THE FRBM ACT PASSED:

The primary objective was the elimination of revenue deficit and bringing down the fiscal deficit. The
other objectives included:

 Establishing a transparent budgetary management system for the nation

 Making sure that debt is distributed fairly over time
 Ensuring long-term fiscal stability

The act also intended to give the required flexibility to the Central Bank for managing inflation in
India.

FEATURES OF THE FRBM ACT:

The act stipulated that the following had to be presented to Parliament each year, together with the
Budget documents:

 Statement of the Macroeconomic Framework

 A statement of the medium-term fiscal policy
 A statement of the fiscal policy strategy

It was suggested that the medium-term fiscal policy statement project the four fiscal indicators of
revenue deficit as a percentage of GDP, fiscal deficit as a percentage of GDP, tax revenue as a
percentage of GDP, and total outstanding liabilities as a percentage of GDP.

TARGETS AND FISCAL INDICATORS AS PER THE FRBM ACT:

As per the latest target of the FRBM Act:

 By March 31, 2021, the government must keep its budget deficit at 3% of the GDP or less
 By 2024–2025, the government must keep its total debt to no more than 40% of GDP

COMMITTEES ON THE FISCAL RESPONSIBILITY AND BUDGET MANAGEMENT ACT:

The government established the NK Singh committee in 2016 to evaluate the FRBM Act. Reviewing
the FRBM Act's effectiveness and making recommendations for amendments to the act's provisions
were the tasks at hand. According to the committee's recommendations, the government should
aim for a fiscal deficit of 3% of GDP in the years leading up to March 31, 2020, then reduce it to 2.8%
in 2020–2021 and 2.5% in 2023.

LATEST UPDATES:

The administration will alter the FRBM Act in 2021–2022 to account for the increased budget deficit
and has not yet set a goal for the next three years. In 2021–2022, the budget deficit is expected to
be 6.8% of GDP, down from the previously estimated 9.5% in 2020–2021 (4.6% in 2019–2020). The
finance minister declared the government's goal to gradually lower the fiscal deficit to 4.5% of GDP
by 2025–2026 in the Union Budget 2021 address.

N.K. Singh Committee

OBJECTIVES:

The objectives of the N.K. Singh Committee were the following:

 Thoroughly examine the FRMB Act considering recent changes, past outcomes, worldwide
best practises, and economic events around the world
  Provide the nation with a plan and future fiscal framework

 The committee's mandate was then expanded to include gathering input on various
proposals made by the 14th Finance Commission and the Expenditure Management
Commission

RECOMMENDATIONS:

The committee submitted its report in January 2020, and it was made public in April that year. The
major recommendations of the N.K. Singh Committee are discussed below:

 It suggested substituting the Debt Management and Fiscal Responsibility Bill, 2017 for the
FRBM Act, 2003

 Debt-to-GDP Ratio:

o By FY 2022–23, the federal government's debt-to-GDP ratio should be 38.7% and the
combined state governments' debt-to-GDP ratio should be 20%

 Fiscal Deficit

o By FY 2022 – 23, the fiscal deficit should be 2.5% of GDP

 The committee suggested that the aforementioned aims be achieved by a "glide route," or
by making steady progress in that direction by meeting annual goals until 2023

 Fiscal Council, it recommended the setting up of an autonomous Fiscal Council, whose role
would be –

o To create long-term financial forecasts

o To enhance the quality of financial data
o To advise adjustments to the financial plan
o To assist the government with its finances

 The committee recommended that the government could deviate from the targets in the
following scenarios:

o Agribusiness collapse affecting revenues and production; national catastrophe; war;

national security implications
o Economic structural changes with financial repercussions
o A fall in real output growth that is at least 3% lower than the four-quarter average

 The debt trajectory for each state should be recommended by the 15th Finance Commission
based on that state's prior record of sound fiscal management

 The centre should borrow from the Reserve Bank of India only when:

o It must make up a short-term revenue shortfall

 o It must make up a short-term revenue shortfall
o The RBI purchases G-secs in the secondary market

 Compatibility of monetary and fiscal policies

o The committee advised that complementary monetary and fiscal policies be used to
guarantee macroeconomic stability and growth
o To do this, there must be interaction between the fiscal laws and the inflation
targeting system

Impact & Analysis

The Central Government has been on the constantly forayed to contract its fiscal deficit over the
past 2 decades, but with the ensuing developmental targets and multiple global crisis situations
faced, government has not been able to keep itself in line with the targets set by the FRBM Act,
2003.

The Fiscal Deficit expanded by 20% from FY19 to FY20 but with the advent of Covid-19 it expanded
by 140% to finance the urgent needs of the nation. Over the next 2 years, the government has tried
to reduce its deficit and is trying to repay the borrowed funds.

Fiscal Deficit Financing Patterns – The Government generally depends on the market borrowings to
fund its fiscal deficit but during and post Covid, there has been a large uptick in the securities
borrowed against small savings which is presently constituting around 25% of the total fiscal deficit
of the government. The Central Government does not have a huge dependence on the external debt
financing.
It saw a sharp rise
during Covid but
the following
year, the

government repaid most of the borrowed funds and this component currently constitutes a smaller
part in fiscal deficit financing than pre-
Covid times.

With the introduction of N.K. Singh Committee, the Central and State Governments’ debt to GDP
ratio is more aligned and has been showing a more positive correlation in the recent years which
wasn’t the case earlier.

The major chunk of the government’s total debt is through Internal Sources. Thus, we compared the
prevailing and the past Call Money Rates, 91 Day T Bill Rates, 182 Day T Bill Rates, 364 Day T Bill
Rates and 10 Year G Sec rates with the Fiscal Deficit over the years.

They have been negatively correlated in the past, which is contrary to the popular belief, that with a
decrease in the fiscal deficit the borrowings rates should have also declined due to a resilience in the
economy and better financial prudence but this was not the trend being followed due to external
macro-economic factors such as demonetisation and GST bills that were introduced in the past 2
years which did not instil the confidence of investors in the economy thus there is a strong negative
correlation. With the Covid crisis and a reinstation of belief in the economy, the T-Bill rates and 10-
year Government Security rates are positively correlated in the recent years which is the trend that
should be followed in the following years and years to come.

Thankyou!