With the budgetary session looming close, ‘fiscal deficit’ is a term you are expected to hear multiple times. So, we decided to write a post to demystify the concept for our readers.
The Fiscal deficit is the gap between revenues and expenditure of the Government. Simply put, when Government spends more than it earns, it is called the fiscal deficit.
It basically indicates how much money the Government will have to borrow to meet its expenditure and fix the deficit gap. This deficit is usually expressed as a percentage of GDP.
The Government earns revenues/ receipts through the following sources: tax revenues, non-tax revenues (like fees, fine, Public Sector Undertaking’s profit etc.), recoveries of loans from state Government and other miscellaneous receipts.
[Note that we do not consider Government borrowings as a part of the receipts to calculate fiscal deficit. Government borrowings are required to finance the fiscal deficit gap]
Fiscal deficit = Government revenue – Government expenditure
To illustrate the concept we take the data of the financial year 2013-14, the total revenue (R) in the year was Rs.1056589 crores while the total expenditure (E) was Rs. 1559447 crores. Thus, we can see that the expenditure exceeded revenues and the fiscal deficit was Rs. 502858 crores. The Government will have to borrow this amount to finance the excess expenditure.
If this fiscal deficit is expressed as a percentage of the GDP value for the same year, it comes out to be 4.4 % of GDP.
Similarly, the fiscal deficit in the financial year 2014-15 was 4% of GDP. The budget of 2015-16 had targeted the fiscal deficit at 3.9 % of GDP.
How is the fiscal deficit different from revenue deficit?
Revenue deficit takes into account the gap between revenue income and expenditure only.
- Revenue income is receipts under the head tax and non-tax revenues. Loans recovered from state Government and other miscellaneous receipts are excluded.
- Revenue expenditure is the expenses which are regular and recurring in nature and which does not add to the productive capacity of the economy. Example: salaries, subsidies, general administrative expenses etc.
- Revenue deficit signifies that a Government’s own earning is insufficient to meet its normal functioning. It does not add to the productive capacity of the country.
The fiscal deficit is the gap between total revenues and expenditure of the Government. Hence, fiscal deficit includes capital receipts and expenditure as well.
- Capital receipts are recoveries of loans and advance payment to state Governments, borrowing, disinvestment income etc. (Note: We do not include borrowing to calculate fiscal deficit).
- Capital expenditure includes loans given to state govt for financing projects, expenditure on defence, infrastructure, roads etc.
- A high Fiscal deficit can take place either due to high revenue deficit or high capital expenditure. Capital expenditure adds to the productive capacity of the nation and is preferred.
We have another concept called Primary deficit as well. The primary deficit is calculated by deducting interest payment made by the Government on its borrowings from the fiscal deficit.
The Fiscal deficit is not necessarily bad for the economy. Sometimes a Government borrows and spends more to give a boost to the economy and also to get the economy out of recession. It was done by the USA after the financial crisis of 2008.
But, this borrowed money should be used for productive purposes, that is, which will generate revenue in the future (also called capital expenditure like infrastructure etc). If it is used for revenue expenses, it can lead to inflation and a further slowdown of the economy.
The Government had passed the Fiscal Responsibility and Budget Management Act (FRBM) in 2003 to impose financial discipline on the country. After the Act came into effect, the fiscal deficit came down from 6.1% in 2001-02 to below 3% in 2007-08. However, the fiscal consolidation process was derailed during 2008-09 and 2009-10 and it has been above 4 % level ever since.
As per the Act, a fixed deficit target must be fixed in the budget every year and the Government should stick to it. This year (2016-17) the Government is expected to fix the target at 3.6 % of GDP.
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