Context:
In her interim budget 2024-25 speech Finance Minister Nirmala Sitharaman announced that the centre would reduce its fiscal deficit to 5.1% of GDP in 2024-25.
Govt Lowers Fiscal Deficit to 5.1% of GDP For FY25
- The finance minister set a fiscal deficit target of 4.5% of GDP for 2025-2026.
- Estimated Fiscal Deficit of 2024-2025: 5.1% of GDP.
What Is Fiscal Deficit?
- Fiscal deficit refers to the shortfall in a government’s revenue when compared to its expenditure.
- When a government’s expenditure exceeds its revenues, the government will have to borrow money or sell assets to fund the deficit.
- Fiscal Deficit= Total Expenditure- Total Receipts (excluding borrowings).
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- Tax Receipts: ₹26.02 lakh crore
- Total Revenue: ₹30.8 lakh crore
- Total Expenditure: ₹47.66 lakh crore
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Distinction From National Debt:
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- The national debt is the total amount of money that the government of a country owes its lenders at a particular point in time.
- Fiscal deficit is a component of national debt but represents annual shortfall.
How Does Government Fund Its Fiscal Deficit?
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Domestic Sources:
- Issuing Govt Bonds: The govt sells bonds to individuals, institutions, and other investors, who essentially lend them money. The govt pays interest on these bonds until they mature.
- Treasury Bills: These are short-term debt instruments issued by the government, typically maturing in less than a year. They are often used to manage cash flow fluctuations.
- Borrowing from Central Banks: Central banks lend money directly to the govt. This causes inflationary consequences if not managed carefully.
- The RBI purchases the bond through what are called “open market operations” by creating fresh money, which in turn can lead to a higher money supply.
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International Sources:
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- Issuing Sovereign Bonds: Similar to domestic bonds, they can sell bonds to international investors in foreign currencies.
- Loans from International Organizations: International organizations like the World Bank of International Monetary Fund (IMF) can provide government loans under certain conditions.
- Bilateral Loans: Governments can borrow from other countries directly depending on interest rates, maturity, and risk tolerance.
Positive Aspect of Fiscal Deficit
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Negative Aspect of Fiscal Deficit
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- Stimulating Economic Growth: Government spending financed by deficits can inject money into the economy.
- It will eventually lead to increased demand and create jobs in the market, which is crucial for pulling the economy out of recession as witnessed post-pandemic in 2021.
- Investing in Infrastructure Projects: Deficits can be financed to invest in public infrastructure projects like roads, bridges, hospitals, schools, etc which will have long-term benefits for economic growth.
- International Bond Market Access: A lower fiscal deficit may help the government to more easily sell its bonds overseas and access cheaper credit.
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- Rising Inflation: If the government earns less and spends more, it needs to print more money to balance the debt. This increases money circulation in the market and leads to inflation.
- Crowding Out: Private investment can be crowded out by fiscal deficit because the govt competes with private sectors for resources. When govt borrows more money, it takes money away from the private sector making it difficult for them to invest and do business.
- Debt Trap: It is caused by the vicious cycle of increasing debt. It happens when govt borrows more money to repay its existing debt.
- Debt Management: A high fiscal deficit can also adversely affect the ability of the government to manage its overall public debt.
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What Lies Ahead?
- Fiscal Deficit Target: The government aims to reduce its fiscal deficit, which is the gap between its total revenue and total expenditure, to 5.1% of the Gross Domestic Product (GDP) in the fiscal year 2024-25. This indicates a commitment to control spending and manage finances more efficiently.
- Revenue Sources: To fund its spending plans, particularly in boosting capital expenditure and other programs, the government intends to rely heavily on tax collections. It anticipates an increase of 11.5% in tax collections compared to the previous fiscal year.
- Expenditure Adjustments: The government plans to reduce expenditure on subsidies, specifically fertilizer and food subsidies. It has also projected a cut in expenditure on fertilizer subsidy, from ₹1.88 lakh crore in 2023-24 to ₹1.64 lakh crore in 2024-25.
- Balancing Act: While increasing taxes can bolster revenue, it may also dampen economic activity by reducing disposable income and consumption. Striking a balance between revenue generation and promoting economic growth is crucial.
- Fiscal Reduction and Management (FRBM) Act 2003: It aims to establish financial discipline, improve the management of public funds, and reduce fiscal deficits.
- NK Singh Committee Recommendation: The central government set up the NK Singh Committee in May 2016 to review the FRBM Act. The N K Singh Committee suggested the following:
- Targets: The primary fiscal policy target should be debt, with a goal to be achieved by 2023.
- Fiscal Council: Establish an autonomous Fiscal Council with a chairperson and two members appointed by the Centre.
- Deviations: Clearly specify grounds for government deviations from FRBM Act targets.
- Borrowings: Define conditions under which the government can borrow from the RBI, limiting it to specific circumstances such as temporary shortfalls or financing deviations through government securities.
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Conclusion
Fiscal consolidation measures can involve tough policy choices and may have short-term economic costs including reduced public spending but it underscores the importance of structural reforms to enhance productivity and competitiveness.
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News Source: The Hindu
February 10, 2024