A file photo of Nirmala Sitharaman
A file photo of Nirmala Sitharaman

Fiscal deficit may not matter much during slowdown

  • As expenditure expands while revenue falls short of budgeted expectations, the fiscal deficit will rise. Mint explains why fiscal deficit doesn’t matter much during a slowdown

India’s economic slowdown has led to a severe revenue shortfall in direct and indirect taxes. As expenditure expands while revenue falls short of budgeted expectations, the fiscal deficit will rise. Mint explains why fiscal deficit doesn’t matter much during a slowdown.

What exactly is a government deficit?

Government finances are adequately discussed during the budget and at times of slowdown. One such indicator of interest is the deficit of the government. There are three measures of government deficits. Revenue deficit is the difference between the total expenditure of the government and its total revenue. Fiscal deficit is the difference between total expenditure and its total revenue except borrowings. Primary deficit is the difference between fiscal deficit and interest payments. Fiscal deficit is one of the most discussed of the three, as it is the money the government borrows to meet its expenditure.

A tenuous link
A tenuous link

So, is it bad if the fiscal deficit increases?

A natural inclination is to believe that if the expenditure is greater than the revenue, then it must be a bad thing. Unfortunately, there’s no simple answer to this question. 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, what really matters is how the borrowed money is being utilized. If it is utilized for 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.

What is the expected fiscal deficit for FY20?

The budget estimates indicated a fiscal deficit close to 3.3% of GDP that seemed unrealistic given the extent of the current economic slump. The FRBM Act allows a 0.5 percentage point relaxation in deficit in the event of a severe slowdown. This allows the government a fiscal deficit till 3.8% without violating the provisions of the FRBM Act.

How does fiscal deficit impact inflation?

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

Can the govt keep on spending as it wants?

Not at all. Though fiscal deficits may not impact inflation, they do impact interest rates—the cost of government borrowings. A higher cost of borrowing constrains government borrowings. In the present situation, the government must respond with a countercyclical fiscal policy. Luckily, that has been the stance of the finance ministry; however, it must share a credible long-term, medium-term fiscal consolidation road map.

Karan Bhasin is a Delhi-based policy researcher.

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