While hearing budget speeches or listening to any economist, there is one very common term which we all have heard very frequently- “Fiscal Deficit“. Today we will understand the basic concept, meaning, implications and importance of Fiscal Deficit in a country’s economy.
Our parents have always been good financial managers. You must be wondering how parents come into the picture when we are talking about such a topic. Don’t worry by the end of this article we will see how this activity which is performed at such a small level like our house is also performed by a country on the same lines.
Understanding Fiscal Deficit
The term fiscal deficit was first used in India during the budget speech of 1991-92 by the then Finance Minister Dr. Manmohan Singh.
Fiscal means anything concerning the government’s revenue whereas Deficit means a shortfall.
So Fiscal deficit means a shortfall of government’s revenue over its expenditure. In simple words, whenever the government is spending more than what it is earning, fiscal deficit arises. We all must have seen how our parents prepare the house’s budget at the beginning of the month. Budgeting activity means listing down all the predictable expenditures for the month and against the expenses listing down the income which is expected to be received in the same month. If the income is more than expenditure we call it Savings and if the expenditure overshoots the income then we have a deficit.
In the case of savings, people generally invest in various types of options like Bank Savings account, Fixed Deposit (FD), Shares, mutual funds, etc. But in case of deficit, we either tend to reduce the expenditure so that deficit would not arise or if the expenditure is non-negotiable then we seek a loan from our relatives, friends, neighbors or even approach the bank for loans.
The same thing happens with every country’s government also. Every government prepares its budget but unlike our monthly budget countries prepare their annual budget. In this union budget, the government list down their revenues and expenses.
For a common man like us, our revenue is the income from our salary, house Rent or FD interest, etc. For the government, revenues are generally the taxes collected by them like Income Tax, GST, VAT, Excise Duty, entertainment tax, etc. These taxes are paid by the citizens which are in a way an expenditure for us but this same expenditure of ours becomes the source of revenue for the government.
Whereas expenditure for the government is all the social welfare activities carried out by them for its citizens. For example constructions of Flyovers, Schools, subsided distribution of food items to Ration Card holders, free medical services at government hospitals, etc.
How Fiscal Deficit Is Calculated
Fiscal Deficit = Total expenditure – Total Receipts excluding borrowings
*Difference between the two shows the borrowings requirement of government to meet the expenditure hence borrowings are excluded.
The greater the fiscal deficit is, the greater the borrowing requirement of the government.
So, if the total expenditure of the government is 2 lac crores while the total receipts (revenue) are only 1.7 lac crores, then the fiscal deficit will be 2,00,000 crores- 1,70,000 crores = 30,000 crores.
The size of a country’s fiscal deficit would depend upon the objectives that the economy sets to achieve by undertaking the deficit. Thus for a meaningful comparison, the country’s fiscal deficit is usually communicated as a percentage of its gross domestic product (GDP).
GDP is the market value of all the finished goods produced within the borders of a country irrespective of products produced/manufactured by a foreign citizen or its own citizen over a specific period.
GDP helps us to understand the health of the Country’s economy. Many economies of different countries in the world are compared based on their GDP. Whether an economy of any country is growing or not is determined based on GDP’s growth.
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Now as we have understood the concept of GDP also. Let’s understand the above formula with an example, suppose the fiscal deficit of India is 30,000 cores and GDP is 8,00,000 cores,
Importance and Implications of Fiscal Deficit
The fiscal deficit is a common phenomenon in every country’s budget. In fact, fiscal surplus is a rare phenomenon. The majority of countries have fiscal deficits only instead of fiscal surplus.
To monitor the fiscal deficit in India, an act was established in 2003 Fiscal responsibility and Budget Management (FRBM) Act 2003 . As per FBRM Act, the ideal Fiscal deficit will be 3 % of GDP.
Fiscal deficit impacts the economy in many ways, some of the major ones are inflation, Debt Traps, and the economy’s growth.
- Inflation: To meet its fiscal deficit, the government sometimes borrows from the Reserve Bank of India (India’s central bank). RBI prints new currency notes which increases money circulation in the economy. It means people have more money at disposal and they are ready to pay a higher price for the same product. This, in turn, increases inflation.
- Debt Cycle: To meet its fiscal deficit, the government will borrow. The government will not only have to repay the principal but the interest component also. So higher the borrowing, higher will be the interest payment. These borrowings if not repaid and monitored will lead to further more borrowings to repay the earlier borrowings which creates a vicious cycle of borrowings.
- Economy’s growth: It tells the economic growth of any country. Higher the deficit, bad is the condition of the economy as the country’s resources will be used to repay the loans/borrowings.
Despite the above explanations, we should understand that this is not a bad phenomenon for a country as long as the expenditures are being incurred to finance activities leading to the creation of national assets like flyovers, hospitals, employment generation, etc.
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I hope this article will help you to understand the very basics of this topic and how it is practiced at even our houses. Let us know your views in the comment section.