Unit 10 BE

BUDGET, BUDGET DEFICIT

What is a Budget Deficit ?

 Meaning ↓

When the government expenditure exceeds revenues, the government is
having a budget deficit. Thus the budget deficit is the excess of government
expenditures over government receipts (income). When the government is
running a deficit, it is spending more than it's receipts.
Types of Budgetary Deficit

 The different types of budgetary deficit are explained in following points :-

 1. Revenue Deficit
 Revenue deficit is excess of total revenue expenditure of the government over its total revenue
receipts. It is related to only revenue expenditure and revenue receipts of the government.
Alternatively, the shortfall of total revenue receipts compared to total revenue expenditure is
defined as revenue deficit.Revenue Deficit takes place when the revenue expenditure is more
than revenue receipts. The revenue receipts come from direct & indirect taxes and also by way
of non-tax revenue.The revenue expenditure takes place on account of administrative expenses,
interest payment, defence expenditure & subsidies. Table below indicate revenue deficit of the
central government of India. Revenue deficit = Total Revenue expenditure – Total Revenue
receipts
 2. Budgetary Deficit
 Budgetary Deficit is the difference between all receipts and expenditure of the government,
both revenue and capital. This difference is met by the net addition of the treasury bills issued
by the RBI and drawing down of cash balances kept with the RBI. The budgetary deficit was
called deficit financing by the government of India. This deficit adds to money supply in the
economy and, therefore, it can be a major cause of inflationary rise in prices.Budgetary Deficit
of central government of India was Rs. 2,576 crores in 1980-81, it went up to Rs. 11,347 crores in
1990-91 to Rs. 13,184 crores in 1996-97.
 Budgetary deficit has not figured in union budgets since 1997-98. Since 1997-98, instead of
budgetary deficit, Gross Fiscal Deficit (GFD) became the key indicator.
 3. Fiscal Deficit
 Fiscal deficit is defined as excess of total budget expenditure over total budget receipts excluding
borrowings during a fiscal year. In simple words, it is amount of borrowing the government has to
resort to meet its expenses.Fiscal Deficit is a difference between total expenditure (both revenue
and capital) and revenue receipts plus certain non-debt capital receipts like recovery of loans,
proceeds from disinvestment. Fiscal deficit = Total expenditure – Total receipts excluding
borrowings = Borrowing
 In other words, fiscal deficit is equal to budgetary deficit plus governments market borrowings and
liabilities. This concept fully reflects the indebtedness of the government and throws light on the
extent to which the government has gone beyond its means and the ways in which it has done so. in
1980-81, fiscal deficit was Rs. 7,733 crores. Between 1980-81 and 1990-91 it increased 5 times to
Rs. 37,606 crores. Since the introduction of economic reforms in 1991-92, the government has tried
to restrict the growth of fiscal deficit. As percentage of GDP fiscal deficit declined from 6.2% in
2001-02 to 4.1% in 2005-06.
 4. Primary Deficit
 Primary deficit is defined as fiscal deficit of current year minus interest payments on previous
borrowings. In other words whereas fiscal deficit indicates borrowing requirement inclusive of
interest payment, primary deficit indicates borrowing requirement exclusive of interest payment
(i.e., amount of loan).The fiscal deficit may be decomposed into primary deficit and interest
payment. The primary deficit is obtained by deducting interest payments from the fiscal deficit.
Thus, primary deficit is equal to fiscal deficit less interest payments. It indicates the real position
of the government finances as it excludes the interest burden of the loans taken in the past.Primary
deficit of the central governent of India was 16,108 crores in 1990-91, it reduced to 14,591 crores in
2005-06. Primary deficit = Fiscal deficit – Interest payments
Deficit financing (printing of new currency notes):

 Another measure to meet fiscal deficit is by borrowing from Reserve Bank of

India. Government issues treasury bills which RBI buys in return for cash from
the government. This cash is created by RBI by printing new currency notes
against government securities. Thus, it is an easy way to raise funds but it
carries with it adverse effects also. Its implication is that money supply
increases in the economy creating inflationary trends and other ills that result
from deficit financing. Therefore, deficit financing, if at all it is unavoidable,
should be kept within safe limits.
 Deficit financing is the budgetary situation where expenditure is higher than
the revenue. It is a practice adopted for financing the excess expenditure
with outside resources. The expenditure revenue gap is financed by either
printing of currency or through borrowing.
 Various indicators of deficit in the budget are: 
 Budget deficit =      total expenditure – total receipts
 Revenue deficit =    revenue expenditure – revenue receipts
 Fiscal Deficit = total expenditure – total receipts except borrowings
 Primary Deficit = Fiscal deficit- interest payments
 Effective revenue Deficit-= Revenue Deficit – grants for the creation of
capital  assets
 Monetized Fiscal Deficit = that part of the fiscal deficit covered by borrowing
from    the RBI.
 Meaning of Commercial Banks:
 A commercial bank is a financial institution which performs the functions of
accepting deposits from the general public and giving loans for investment
with the aim of earning profit.
 In fact, commercial banks, as their name suggests, axe profit-seeking
institutions, i.e., they do banking business to earn profit.
 RBI produces money while commercial banks increase the supply of money by
creating credit which is also treated as money creation. Commercial banks
create credit in the form of secondary deposits.
Credit Creation

 Creation of credit is one of the most important function of a commercial

banks. Banks take deposits from the customers and provides loans from their
deposits after keeping necessary reserves like cash reserves etc. Actually the
banking system creates credit rather than a bank individually. Let us
understand this by a simple example, Mr A puts deposit worth Rs. 1000 in X
bank. For simplicity assume that there us reserve requirememt of 10%. X bank
can lend Rs 900. Suppose Mr B gets this loan and deposits in his bank account
with Bank Y. Now if forms part of deposits of Y who can lend Rs 810 from the
deposit. This chain continues till the time money remains in banking system.
This process is called credit creation where deposit of Rs 1000 has created
credit more than that. The process stops at the point where money is moved
out of banking system.
 Total deposits of a bank is of two types:
 (i) Primary deposits (initial cash deposits by the public) and (ii) Secondary
deposits (deposits that arise due to loans given by the banks which are
assumed to be redeposited in the bank.) Money creation by commercial banks
is determined by two factors namely (i) Primary deposits i.e. initial cash
deposits and (ii) Cash Reserve Ratio (CRR), i.e., minimum ratio of deposits
which is legally compulsory for the commercial banks to keep as cash in liquid
form. Broadly when a bank receives cash deposits from the public, it keeps a
fraction of deposits as cash reserve (CRR) and uses the remaining amount for
giving loans. In the process of lending money, banks are able to create credit
through secondary deposits many times more than initial deposits (primary
deposits).