Fiscal Deficit: An Overview

What is 'fiscal deficit' and 'debt' of a country?

The very term fiscal means ‘related to government revenue and treasury’ and the term deficit means ‘the amount by which something is less’. As the term itself suggests, Fiscal deficit of a country is the difference of the total revenue and the total expenditure of the government. This indicates how much the government must borrow in order to successfully finance its strategies (since borrowings are not included in revenue). Very few countries operate at fiscal surplus.

Example – If a country’s revenue is Rs.1,000 and expenditure is Rs.1,100, it has a fiscal deficit of Rs.100. However, if the country’ expenditure was Rs.1,000 and revenue was Rs.1,100, its fiscal surplus would be Rs.100.

The Fiscal Deficit accumulated over the years is known as the 'debt' of the country.

Why is it so important and how is it measured?

Fiscal Deficit(FD) is an important parameter to gauge the government’s overall performance and the sustainability of growth in the future. Fiscal deficit is measured as a percentage of the GDP of the country (and not in absolute terms) to understand its impact on the growth of the nation.

Example – If the fiscal deficit for year 21X5 was Rs.100 and it is Rs.110 for the year 21X6, one may think that the expenditure has surpassed the revenues even further and it is bad for the country. But, what if the GDP of the country has increased from 2000 to 2400 during the same time? The change in ratio of fiscal deficit to GDP has gone down from 5.0% to 4.5833%. The 2 ways of measuring fiscal deficit tell us 2 different stories about the economy and its direction.

Before drawing conclusions, one needs to realize that for any growth or creation of an asset, expenditure is a must. But if the country grows faster than it spends, then increase in expenditure is rather good and it can safely be assumed that the government is working towards the development of the nation. Hence, expressing it in terms of GDP shows the actual scenario of the country at hand.

But higher fiscal deficits for a long time will put the country into some serious debt.

How does government finance the FD?

1. It financed by borrowing the money from the markets. Initially, the government would issue bonds to the main bank of India, The RBI and borrow money from them. Now, an auction takes place in the market, which is facilitated by the RBI. Primarily it tries to buy from the domestic sources.

2. Borrowing from external sources like the world bank , IMF, etc. This hurts the value of the currency with respect to other currencies and might lead to “trade deficit”

3. Printing new currency. This takes a hit at the value or the ‘buying-power’ of the currency. This is one of the reasons for inflation rate going high and products becoming more expensive.

4. The government can also resort to ‘sucking out’ money from the profit-making PSUs in which it holds a significant % of shares. It is done by announcing share buy-backs and dividends. These methods have been recently tried by the Modi-led government in companies like ONGC, BHEL, NTPC and a few others. This can be a good way of using the unallocated cash reserves of the companies but overuse might bring the company into debt. Also, it might hamper the prospective growth of the company as it could have invested elsewhere to earn higher profits in the future.

Is Fiscal Deficit bad ??

Economics is a field where extremes are neither good nor possible and everything works best when optimized. The most desirable situation for the country would be that it has fiscal surplus and is rich & developed. But that is rarely the case . The most pathetic situation for a country to be in is when the country has fiscal surplus and yet it is poor – which only highlights the fact that the forlorn government has no plans for the growth of the country in whatsoever field, despite having the money and resources on which it just decides to sit. High fiscal deficits are obviously bad for the country and even a bigger concern if they keep rising. This leaves us with the most encountered situation – countries with a small yet significant percentage of fiscal deficit, as in the cases of countries like India.

Example - Many companies use the debt market for financing its projects and once when the asset is created and put to use, it reaps higher profits. The interests and and the principal amount are all made up for; and from then on the asset keeps on generating 'pure' profit for the remaining of its finite life. Similarly, learning from this, one has to realize that for long term profits and growth, calculated risks and debt is not a bad option. Though it may seem like inconvenience, but if the government has a plan for the country and the people, it shall be ephemeral.

What I think ?

I would like to make a concluding remark - that controlled fiscal deficit is not bad for the long run as it shows that government is continuously working towards building infrastructures and creating jobs for the people. But a rise in its % shall be an alarming situation. What % is ideal varies from country to country based on various factors like trade, core competency, culture, socio-political scenario, GDP growth and many others. Hence, there is no fixed value for it.

This July, India awaits the much talked about Budget, that shall be proposed under the administration of the honorable Finance Minister of India, Mrs. Nirmala Sitharaman (BJP). It is one of the most important days for the Indians, and no doubt it has a huge impact on the Indian Stock Market. I hope that day has some relief and gifts stored for the weaker sections of the society. Jai Hind.

I am also learning further in-depth about this field and hence, if you have your suggestions or views - do comment. Would love to connect.

*Disclaimer - I am no economics professional, rather just an inquisitive investor who is also learning. Different people have different views and so do I. I have elucidated things in manner anyone can understand. I have no intentions to persuade anyone to take any kind of decision or think the way I do. No one can hold me responsible for any of their loss of misinterpretation of the post.