fiscal-deficit-may-not-matter-much-during-slowdown

Why is it in the news ?

India’s economic slowdown has led to a severe revenue shortfall in direct and indirect taxes.

  • Amid debilitating conditions of Indian economy, the Government undergoes the dilemma either to follow the path of fiscal consolidation or to choose fiscal expansion.

What are the types of Government deficit ?

There are three measures of government deficits.

  1. Revenue deficit is the difference between the total expenditure of the government and its total revenue.
  2. The fiscal deficit is the difference between total expenditure and its total revenue except for borrowings.
  3. The primary deficit is the difference between fiscal deficit and interest payments.

Fiscal deficit: A problem or not ?

  • A prolonged fiscal deficit above 4% is likely to be problematic, but there’s little difference between a deficit of 3.5% or 3.8%.
  • More than the amount of fiscal deficit, its manner of utilization is of much concern.
    • If it is utilized for the construction of physical infrastructure, then it is not necessarily a bad thing.
    • But if it is used for farm loan waivers or other such subsidies, then a high fiscal deficit should be a cause of major concern.

Fiscal deficit

It is the difference between Total Revenue and Total Expenditure of the government.

Mathematically,

  • Total Expenditure  = Revenue Expenditure + Capital Expenditure
  • Total Revenue = Revenue Receipts + Capital Receipts + Recovery of Loans - Borrowings
  • Fiscal Deficit = Total Expenditure - Total Revenue

Implications:

  1. The fiscal deficit is a key marker that indicates the excess of revenue expenditure.
  2. To bridge this difference, the government needs to borrow money from the market.
    1. Though fiscal deficits may not impact inflation, they do impact interest rates—the cost of government borrowings.
    2. A higher cost of borrowing constraints government borrowings.
  3. A study shows that Capital Expenditure has a Multiplier effect (evaluated in terms of a change in the nominal GDP or total incomes) of 2.5 while Revenue Expenditure has a Multiplier effect of less than 1.

Terms :

Revenue Expenditure

  • The expenditure for paying salaries and other such expenses is termed as revenue expenditure.

Capital Expenditure

  • The expenditure that is used for building infrastructure, that in turn increases the production capacity of the economy.

What are the impacts of the Fiscal deficit on prices ?

  1. Conventional wisdom has been that fiscal deficits result in undue inflationary pressures.
  2. This is based on India’s experience with high deficits in the 1980s and from 2009 onwards when inflation and fiscal deficits were both high.
  3. But an important fact during these two periods was high international prices of global commodities and high minimum support prices for farmers.
  4. Moreover, not all deficits are inflationary: if the additional money is utilized for investments rather than subsidies, inflation is likely to be muted.