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A large fiscal deficit can also impact a country’s rating
A large fiscal deficit can also impact a country’s rating

How fiscal deficit has a bearing on inflationary woes

Fiscal deficit is difference between total government receipts (taxes and non-debt capital) and total expenditure. Its size affects growth, price stability, and cost of production and overall inflation. A large fiscal deficit can also impact a country’s rating. Mint explores.

Fiscal deficit is difference between total government receipts (taxes and non-debt capital) and total expenditure. Its size affects growth, price stability, and cost of production and overall inflation. A large fiscal deficit can also impact a country’s rating. Mint explores.

What has been India’s fiscal deficit trend?

The Centre breached the fiscal deficit target for FY19-20, as per Controller General of Accounts. The gap is financed by borrowings from financial markets like any private player. The Fiscal Responsibility and Budget Management (FRBM) Act, 2003, aims to establish financial discipline by reducing fiscal deficit, thereby improving macroeconomic management and strengthening fiscal judiciousness. Its long term goal is for the country to achieve fiscal stability. However, the Act allows the invoking of an escape clause in situations of calamity and national security.

Does fiscal deficit result in inflation?

Fiscal deficit can lead to cost-push inflation. The government being a major player in the market for borrowings and doing away with the practice of getting currency notes printed (since 1991) exerts an upward pressure on interest rates. Higher interest rates increase production cost, which is passed on to consumers, thereby leading to higher prices. The degree of impact on inflation is dependent on the quality of expenditure. Fiscal deficit due to productive investment may have less impact as it takes care of both the rise in demand and supply in comparison to expenditure where productive activities do not occur.

Potential impact
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Potential impact

How has the pandemic impacted India’s deficit?

With the lockdown resulting in all economic activities grinding to a halt, government revenue collections drastically declined. On the other hand, stimulus expenditure resulted in a substantial increase in government expenditure, leading to fiscal deficit of 6-7% of gross domestic product (GDP) for FY2021 against the budgeted 3.5%.

Does fiscal deficit result in growth?

Fiscal deficit can boost a sluggish economy.  Money  spent on  creation of productive assets creates investment and job opportunities. Fiscal deficit increase because of non-asset creation, such as welfare measures, generates purchasing power among the poor, thus helping in kickstarting a recessionary economy. During the Great Depression, economist John Keynes suggested making people dig up wells and fill up the same. Though no tangible asset was created, the wages earned by the people generated demand.

Why is India’s inflation rate higher than rest?

Prior to 1991, India saw double digit inflation. Less developed financial markets with weak bond between interest rates and aggregate demand is the key reason. Doing away with budget deficit practice under which the government had the luxury of getting currency printed, fall in peak indirect taxes and the government’s obligation to FRBM Act has seen inflation levels declining. In advanced economies, central banks are more effective in controlling inflation.

Jagadish Shettigar and Pooja Misra are faculty members at BIMTECH.

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