INTEREST RATES RISE DUE TO

FISCAL DEFICITS?

Presented By:
Group 4
Amal Dev V (191066)
Amit Gandhi (191068)
Anirban Samaddar (191070)
Dhananjay Kumar (191083)
Hardeep Singh (191086)
Hiralal Senapati (191087)
FISCAL POLICY
 Fiscal Policy is concerned with Government
Expenditure, its composition and sources of financing it.

 To correct situation of demand deficiency and excess

demand

 Fiscal policy choices:

Expansionary fiscal policy
Contractionary fiscal policy
COMPARISON BETWEEN
EXPANSIONARY & CONTRACTIONARY
FISCAL POLICY
OBJECTIVES

 Price Stability
 Employment Generation
 Infrastructure Development
 Promotion of a particular Sector
 Narrow down regional disparities
 Optimum utilization of resources
FISCAL POLICY IN INDIA

Government
Finances

Revenue Capital
Account Account

Revenue Revenue Capital Capital

Expenditure Receipts Expenditure Receipts
GOVERNMENT RECEIPTS
 Revenue Receipts
• Tax Revenue
• Non-Tax Revenue
 Capital Receipts

• Disinvestments
• Borrowings
• Recovery of Loans
GOVERNMENT EXPENDITURE

 Revenue Expenditure
• Employee Wages
• Interest
• Subsidies
• Maintenance of Infrastructure
 Capital Expenditure
• Infrastructure
• Loan to States
• Principal Amount
 Government Expenditure can be divided into planned
and non-planned expenditure.
 Planned expenditure includes central assistance for states
and union territories, central planned expenditure based
on Planning Commission recommendations etc.
 Non-planned expenditure includes subsidies, pensions,
grants, defense expenditure etc.
FISCAL DEFICIT
 When a government's total expenditures exceed the
revenue that it generates (excluding money from
borrowings).
 Deficit differs from debt, which is an accumulation of
yearly deficits.
 Total Government Expenditure - Total Government
receipts > 0 ( Fiscal Deficit)
 Total Government Expenditure - Total Government
receipts < 0 ( Fiscal Surplus)
FINANCING DEFICIT

 Borrowing from the Central Bank

 Monetized

 Borrowing from domestic market

 Increase in Taxes

 Borrowing from Abroad

 Bilateralsources (another country)
 Multilateral sources (IMF, World Bank, ADB, etc.)
WORKING PAPER BY IMF
 This paper examines the relationships between interest
rates and fiscal deficits.
 This paper assesses the impact of fiscal deficits and
public debt on long-term interest rates during 1980–
2008.
 This research paper takes into account a wide range of
country-specific factors, for a panel of 31 advanced and
emerging market economies like Australia, Brazil, U.S.,
U.K., South Africa, Canada etc.
 This paper proposes that higher deficits and public debts
increases the interest rates.
DOES THIS THEORY HOLD IN INDIA?
OBSERVATIONS
 Government is able to borrow money from the market at
a cheaper rate than borrowers from Banks.
 Deposit holders on an average get a return from bank
which is lower than what receives from Government
securities.
 Banks charge higher rate to borrowers.
RELATIONSHIP BETWEEN INTEREST
RATE & FISCAL DEFICIT
9

5
Fiscal Deficit
4 Interest Rate

0
FY05 FY06 FY07 FY08 FY09 FY10
CROWDING OUT
 The ratio of incremental credit to fresh Government
securities issues has declined over time.
 There could have been a crowding out of private sector.
CROWDING OUT CONT..
OTHER FACTORS AFFECTING THE
INTEREST RATE
 Credit – Deposit ratio has remained high (above 70 % in
last five year)
 Buying/Selling of securities by RBI through Open
Market Operations.
 Implementation of Base Rate (range of 7-8 %)
CONCLUSIONS
 Higher borrowing do not increase interest rate.
 RBI ensured that there is no crowding out through OMO
& phasing of auctions.
 Commercial lending rates increased due to higher cost of
deposits and regulatory compliance – but less due to
government borrowing.