Saturday, August 3, 2013

 What is fiscal deficit: Basics explained

By Mowna Ravikumar | Yahoo! Finance India – Wed 31 Jul, 2013 4:01 PM IST
Every time economists sense India is or will be in trouble, the phrase fiscal deficit often pops up. While some experts believe that fiscal deficit is a positive that helps the country grow, conservatives think otherwise, favoring a balanced budget policy.

Here’s a start to understanding what fiscal deficit means and why it really matters to India ’s economic wellbeing.

What is fiscal deficit?

Fiscal deficit is the difference between the government’s expenditures and its revenues (excluding the money it’s borrowed). A country’s fiscal deficit is usually communicated as a percentage of its gross domestic product (GDP).

Considering that the Indian economy is growing between 5 to 5.5 percent in the financial year ended March 2013, fiscal deficit is definitely a challenge to the economy. According to the World Bank, growth in India is projected to rise to 6.5 percent and 6.7 percent in FY2014 and FY2015, respectively.

All said and done, India ’s fiscal deficit has been the centre of debate for many occasions this year. And in April, Finance Minister, P Chidambaram has brought it down from 4.9 percent last year to 4.8 percent of the GDP in 2013-14.

What are the causes of fiscal deficit?

Government spending, inflation and lower revenue are among some of the main factors that point to fiscal deficit. The cynical nature of fiscal deficit does not only jeopardize the growth of the country but also the government’s economic management abilities.

In an ideal financial system, which has a balanced fiscal deficit, the cost of expenditure is low while production and growth is advancing. But when there is an increase in fiscal deficit it means that the government is spending too much while it is earning less. Hence, it is important that the government keeps its expenses under control.

One way the government earns money, is through taxes. For example, if the government lowered taxes or provided tax concessions to a particular group of people, then it would earn less, leading to an increase in fiscal deficit. And that’s one of the reasons why you will find the government giving a face-lift to the tax structures. In the same context, cutting of custom duty and excise duty will lead to declining revenues.

Like India , many developing countries are making an effort to resolve big fiscal deficits. On the bright side, for India , among other sources of revenue, foreign investments and inflow of remittance s from Indians living overseas has helped avoid very high deficits.

Fiscal deficit does not come about only in case of creating less revenue and spending more money. Another major reason for a growing fiscal deficit can be slow economic growth or sluggish economic activities.

How fiscal deficit can be bad for India ?

A large fiscal deficit is an indication that the economy is in trouble and will have reasons to worry. A high fiscal deficit could pose an inflation risk, minimize the growth of the economy, doubt the government’s abilities; it could affect the country’s sovereign rating, which in turn will limit foreign investors from looking at India as one of the investment hubs.

It is believed that high fiscal deficit can be corrected. For example, if the government could not control its expenditures, it could raise taxes to cover up for the extra amount of money spent. When taxes increase, consumers will involuntarily have to cut down on their expenditure to pay the government.

Also, the government expenditure puts pressure on interest rates creating a negative impact on savings. And yes, the Indian government can choose to import money into the country to balance the soaring fiscal deficit, but this move could appreciate the country’s currency and the government will have to pay interest on its borrowings, eventually increasing the deficit and affect the country’s economic growth. Therefore, delay in adjusting high fiscal deficit shows that the government cannot control its finances properly.

Did you know that several government projects are stalled because of high fiscal deficit? Here’s why. When a country labors under high fiscal deficit, it limits the government’s spending capacity and this has an effect on the continuous funds various projects need. Infrastructure projects, or welfare policies, or education and healthcare projects, for example.

The trouble with high fiscal deficit is that it leads to higher interest rates, disturbing the entire economy.

Since the government is not earning much, it will have to restrict its expenses, unless it chooses to borrow. And since the government abilities are doubted due to its incapacity to control its profligacy, it is very difficult for the government to access loans. And even if it gets loans, they are at given at high interest rates. On the one hand, the government borrows because it does not have enough money, and on the other hand, it has to pay more for borrowing money. Hence, fiscal deficit leads to a slow progress of the nation.

Difference between fiscal deficit and budget deficit

Budget deficit is commonly known as the national debt. Budget deficit means that a country has more money going out when compared to the money its earning. Budget deficits can usually be resolved by raising taxes, cutting spending or a combination of both. Unlike fiscal deficit, while calculating budget deficit, the country’s borrowings are taken into consideration. India ’s budget deficit last fiscal year was 4.9 percent of gross domestic product.

In case of fiscal deficit, it can be measured without taking into account the interest it pays on its debt. Fiscal deficit is basically the difference between the money it spends and the money it makes.

Difference between fiscal deficit and current account deficit

Fiscal deficit is a percentage of the nation’s GDP and can be considered as an economic event in which the government expenditure exceeds its revenue. Meanwhile, current account deficit occurs when the country’s imports are greater than the country’s exports of goods, services and transfers.

Most developing countries run a short term current account deficit to boost domestic productivity, which could lead to increase in exports in the future.

After India’s current account deficit hit a historic high of 6.7 percent of GDP in Q3 of last fiscal year, it was at 5 percent of the GDP in the year ended March, making the rupee weak and also making way for lower interest rates.

India’s fiscal deficit and its current affairs

According to government data, India ’s fiscal deficit during 2012-13 financial year was 4.9 percent of the nation’s gross domestic product. While China aims to keep its fiscal deficit below 3 percent this year, let’s take a look at how fiscal deficit is making news in India .

Curbing import on gold is one of the measures taken by the government to correct the country’s fiscal deficit. But with a weakening rupee and increase in global oil prices, the finance minister might put a cap on the country’s expenditure to avoid pressure on fiscal deficit.

In previous years, growing fiscal deficit has given rise to the balance of payment crises. But in the recent years, the government has taken action steps to correct the situation by cutting service taxes, excise duty and carefully stepping up government expenditure. 

Also, when the cabinet decided to come out with the Food Security Bill which guaranteed quality food grains at subsidized rates, the concern of fiscal deficit slipping by 0.5 percent was predicted by experts. And then earlier in July, the Government of India reassured the nation that execution of the Food Security Bill will not affect the fiscal deficit target for the year. 

Fiscal deficit has been a key concern for credit rating agencies and RBI is likely to be on alert when it pays its debt because paying high interests with cautious investors amid rising deficits might not be considered a smart move.

Why is India ’s fiscal deficit continually high?

While the government fights to manage money, here are a few reasons why India has a soaring fiscal deficit. It is high because in the corporate sector, bailouts are becoming common and subsidies are being high. The money that the government earns through non-tax revenue is not big and the money it earns from taxes is not enough.

You can share your views on India ’s fiscal deficit by posting a comment below.

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