Fiscal Deficit Management

Fiscal deficit management is crucial in the current context of declining household financial savings.

Fiscal Deficit

• About: Fiscal deficit is defined as excess of total expenditure over total receipts excluding borrowings during a fiscal year.
  • It reflects the borrowing requirements of the government for financing the expenditure including interest payments.
• Formula: 
  • Fiscal deficit = Revenue expenditure + capital expenditure – Revenue receipts – capital Receipts excluding borrowings.
• Indicator of Future Liabilities: It is an indicator of the increase in future liabilities of the government on interest payment and loan repayment.

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Fiscal Deficit Target in the Budget 2024-25 

• Fiscal Deficit Reduction Goal: The government aims to reduce the fiscal deficit to 4.5% of GDP by 2025-26, down from the budgeted 4.9% for 2024-25.
  • This is part of a broader goal to reduce the debt-GDP ratio, which is projected to be 54% in 2025-26.

• Long-term Debt Management: From 2026-27 onwards, the government’s goal is to maintain a fiscal deficit that ensures the Central government’s debt follows a declining trend as a percentage of GDP.
• Future Goals: The government aims to keep reducing the debt-GDP ratio after 2025-26 but hasn’t set a specific target or timeline. 
  • This means it might not meet the previous target of 40% debt-GDP ratio set by the Fiscal Responsibility and Budget Management (FRBM) Act.

Issues with respect to Increasing Fiscal Deficit

Government expenditures exceeding revenue by a high margin can lead to a difficult situation. 

• Impact on Inflation: A persistently high fiscal deficit can lead to higher inflation as the government may resort to printing new money to fund its deficit.
• Challenges in Public Debt Management: A high fiscal deficit can hinder the government’s ability to manage its overall public debt effectively. 
  • The fiscal imbalance results in a significant rise in public debt as the government borrows more to cover the shortfall.
• Risk of Balance of Payments Crisis: The combination of a large deficit and rising debt creates pressure on the country’s foreign reserves, leading to a balance of payments crisis. 
  • Example: In the 1980s, rising fiscal deficit accompanied by rising government debt led to a difficult balance of payments situation and a high ratio of interest payment to revenue receipts. 
• Rising Interest Payments: The ratio of interest payments to revenue receipts surges, limiting the government’s ability to fund other priorities. 
  • International Comparison:   Between 2015-19, the interest payment to revenue receipts ratio averaged 5.5% for Japan, 6.6% for the UK, and 8.5% for the US. 
  • In contrast, India’s average ratio was much higher at 24% during 2015-16 to 2019-20.
• Increased Borrowing for Development Expenditures: To meet essential developmental expenditures, the government is forced to borrow progressively more, further deepening the fiscal strain.
• Crowding Out of Private Investment:  A high fiscal deficit can lead to higher interest rates as the government competes with the private sector for borrowed funds. 
  • This “crowding out” effect can make borrowing more expensive for businesses, reducing private investment. Lower private investment can stifle economic growth and innovation, ultimately impacting job creation and productivity.

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Possible Solutions For Maintaining Fiscal Deficit 

• Fiscal Consolidation: Implementing fiscal consolidation measures can help reduce the fiscal deficit and stabilize public debt through:
  • Spending Cuts: Reducing government expenditures on non-essential programs and services.
  • Revenue Increases: Raising taxes or improving the efficiency of tax collection.
  • Debt Management: Refinancing or restructuring existing debt to manage interest payments and repayment schedules better.
• Maintaining a Fiscal Deficit of Around 3% of GDP: To support private investment and economic growth, it is important to maintain the fiscal deficit at around 3% of GDP. Exceeding this limit may lead to irresponsible borrowing and financial instability.
• Encouraging Household Savings and Investment: With household savings currently low (5.3% of GDP), efforts should focus on increasing household savings to free up funds for private investment. 
  • This would allow the government to manage its fiscal deficit without crowding out private investment.

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