FISCAL DEFICIT AND

ITS IMPACT ON
GDP
BY ANOUSHKA MISHRA
BA.LLB(H)2 N D YEAR
REG NO:1841802021
WHAT IS 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 .A large deficit means a large amount of
borrowings. Fiscal deficit is a measure of how much the government needs to borrow from the
market to meet its expenditure when its resources are inadequate.
◦ • In the form of an equation: Fiscal deficit = total expenditure – total receipts excluding
borrowings.
CAUSES OF FISCAL DEFICIT
◦ Excessive Government borrowings
◦ ► High levels of Tax Avoidance and Tax Evasion
◦ ► High levels of Income and wealth Inequality
◦ ► High levels of Government Subsidy/Financial Support
◦ ► Poor performance of public sector
◦ ► Unplanned major expenses
◦ ► Periods of economic growth and economic decline
Example

• Current Fiscal Year – FY17

• Period : End October
• Deficit for the period : Rs 4.11 trillion ( 74% of the expected fiscal deficit for FY17)
• Targeted deficit : 3.9 % of GDP for current year
• Governments position : Positive compared to YoY comparison with FY16 as
more deficit is available .
• Plan expenditure stood at 58.2 per cent of the budget estimate
• Tax revenue contributed 46.61% of budget estimate till October
Impact of fiscal deficit on GDP in India
◦ A higher fiscal deficit is not just the government’s headache. It has an impact on all our financial lives
◦ The govt is trying to cut costs, and this is already having an impact on salaries of its employees. Meanwhile, lower returns from bank FDs are a result of
higher govt borrowings
◦ In 2019-20, the central government ran a fiscal deficit of 4.6% of gross domestic product (GDP) against the planned 3.5%. Fiscal deficit is the difference
between what a government earns and what it spends and is expressed as a percentage of GDP.
◦ This huge jump in the fiscal deficit was because the government ended up with gross tax revenue of ₹20.1 trillion against the revised estimate of ₹21.63
trillion, a gap of more than ₹1.5 trillion. Also, any government cannot cut expenditure beyond a point.
◦ The current financial year, 2020-21, is expected to go the same way. With the economy expected to contract during the year, there is a grave danger that the
central government and the state governments may not earn as much tax as they had hoped to, at the beginning of the year.
◦ This will mean higher fiscal deficits for the governments. Current estimates suggest that the combined fiscal deficit of the central and the state governments
could cross 10% of the GDP during this year from the current 7-7.5%.
◦ This is something which will impact you and I. In fact, it already has.
◦ The central as well as some state governments have decided not to increase dearness allowance and dearness relief that they pay to their employees and
pensioners. That also explains why governments have increased the taxes on petrol and diesel; people are paying much per litre than they should have given
the massive collapse in oil prices.
◦ As the governments borrow more to finance their fiscal deficits and accumulate more debt, interest rates tend to go up. The 
Reserve Bank of India (RBI) is trying to drive down interest rates and in the process returns from bank fixed deposits (FDs) have
gone down.
◦ At a larger level, a spike in government borrowing increases the danger of rating agencies downgrading India’s credit rating even
further. This will impact everything from systematic investment plans (SIPs) to the value of the rupee with respect to the US dollar.
◦ Clearly, a higher fiscal deficit is not just something that the government has to deal with, but it also has an impact on our financial
lives.
◦ How it affects spending
◦ In late April, the central government decided that the increase in dearness allowance and dearness relief that was due to its
employees and retirees (pensioners) won’t be paid. Further, it also decided not to pay any increase due until 1 July 2021.
◦ According to a report in Mint, the move will impact 11.5 million employees and pensioners of the central government and help it
save ₹37,530 crore. State governments have also implemented similar measures and are expected to save approximately ₹82,566
crore.
◦ Hence, government employees, both at the central and the state level, are already bearing the cost of the higher fiscal deficit. Typically, in any economic
downturn, the purchasing power of government employees remains intact. But that is not happening this time around. The indirect impact of this loss of
income will mean lesser spending from the government employees and pensioners. This will hurt incomes of many other individuals and businesses.
◦ What does not help is that several governments (like Telangana, for instance) have been unable to pay a full salary to their employees. Again, this means a
cutdown in spending which will impact others.
◦ Desperate governments have been trying to shore up their tax revenues. Take petrol. Between 1 January and now, while oil price is 42.2% lower, the price of
petrol in Delhi has barely fallen by 5.2%. This is primarily because the union excise duty on petrol charged by the central government has been increased
dramatically. The sales tax charged by the state governments has also gone up. Ditto for diesel.
◦ How it affects savings
◦ The slowdown in tax collections was clear even before the last financial year ended on 31 March 2020. This meant that the government would have had to
borrow more to bridge the fiscal deficit. When the government borrows more, it crowds out the private part of the economy which is looking to borrow,
pushing up interest rates in turn for everyone.
◦ To take care of this and a slowing economy, RBI has been trying to drive down interest rates. It has done so by cutting the repo rate or the interest rate at
which it lends to banks to 4% currently, from 5.15% in February 2020. It has also pumped money into the financial system by buying bonds.
◦ As of 1 June, the excess liquidity in the financial system stood at ₹4.02 lakh crore. This is excess money which banks haven’t been able to lend and hence,
have deposited with RBI. In January, the government was able to borrow for 10 years at a yield of 6.6%. By June, this had fallen to 6%.
◦ With so much excess liquidity prevailing in the financial system, interest rates on deposits have gone down. Data from Centre for Monitoring Indian
Economy (CMIE) suggests that between the end of March and 22 May, the interest on fixed deposits is down around 50 basis points. One basis point is one
hundredth of a percentage.
◦ Lower fixed deposit interest rates is another way how people will pay for a huge slowdown in tax revenue collection. One aspect that is often missed out on
is that deposits are a major form of savings for a majority of Indians. If we look at data between 2011-12 and 2017-18, deposits formed around half of
household financial savings.
◦ If deposit rates go down, as they have over the last few years, people need to save more in order to meet their broader saving goals of building a
corpus for the education and wedding of children, as well as having sufficient money for retirement. This has an impact on current
consumption, which has an impact on incomes of others.
◦ Five years back in June 2015, the State Bank of India paid an interest of 8% per year on a 5-year fixed deposit. An amount of ₹1 lakh over a
period of five years would have grown to around ₹1.47 lakh. Currently, the bank offers a 5.4% interest on a five year fixed deposit. At the end
of five years, ₹1 lakh invested will grow to ₹1.3 lakh. Clearly, the difference is significant.
◦ The interest rates on fixed deposits currently largely vary anywhere between 5-6%. In comparison, the small savings schemes pay from 5.5%
(the one-year time deposit) to 7.6% (Sukanya Samridhi Yojana scheme). The interest rates on offer on the small savings schemes are still higher
than the interest rate on fixed deposits.
◦ While the interest rates on small savings schemes in the time to come are likely to go down, the difference between interest rates on these
schemes and fixed deposits is likely to be maintained. This means it still makes sense to have long-term savings parked in these schemes. Other
than higher interest rates, some of these schemes also offer a tax deduction.
◦ The money raised under small savings schemes goes to the National Small Savings Fund (NSSF). The NSSF helps the government bring down
its fiscal deficit. In 2019-20, the government spent ₹1.09 trillion towards food subsidy. A bulk of this food subsidy would have gone to
compensate the Food Corporation of India (FCI) for selling rice and wheat at subsidized prices to meet the need for food security.
◦ The total food subsidy that the FCI had claimed during the year stood at ₹3.18 trillion. Hence, more than ₹2 trillion of FCI’s bill remained
unpaid by the government. If the government had cleared FCI’s bill, its expenditure and fiscal deficit would have shot up. But that hasn’t
happened. The NSSF lends money to FCI to finance a large part of the bill unpaid by the government. By operating through NSSF, the
government avoids a higher fiscal deficit and manages to push the problem to a later date.
◦ For this to continue, it is necessary that money keeps pouring into the small savings schemes. And for that to happen, the interest rates on these
schemes need to be higher than those on banks fixed deposits.
Measures to reduce fiscal deficit
Disinvestment of public sector enterprises.
◦ • Reform in tax structure.
◦ • Reduce public expenditure.
◦ • Increase duties on imported and domestic goods.
◦ • Curb black money
Conclusion
Well GDP consist of the sum of the following elements
◦ Private Consumption
◦ Govt Spending
◦ Investment ( This relates to investment in plant and machinery , land etc )
◦ Net Exports.
◦ So how does Fiscal deficit figure in this?
Well we can see Govt Spending in the list. Does it impact the GDP?
◦ It has to pay salary to all its employees. Does that add to GDP ? In a roundabout way because the Govt Servants do spend their salary. But that is accounted in
the Private Consumption Head.
◦ Govt has to buy consumables like staples, paper etc. Yes but that money is peanuts and you can not change the GDP by a hundredths by buying more stationary.
Here is a way that Govt spending can inmpact the GDP
◦ Govt can use its money to finance infrastructure projects. It awards contracts for building toll roads, toll bridges, power plants, dams, hydroelectric projects,
solar energy projects, etc. All these projects can raise revenue once built. So if the Govt takes a loan and invests it in such projects the project can pay back the
loan. But before payback time, immediately the money spent on the project actually reaches the market and pushes the GDP up.
◦ So we see that if public can not push its consumption up, the Govt can play its part by pushing its Govt Spending.
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