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Fiscal Deficit: Genesis and impact on Indian Economy

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Fiscal Deficit: Genesis and impact on Indian Economy

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General awareness is must to crack any exam and CAT is also no exception. Today, you will read General awareness topic : Fiscal Deficit: Genesis and impact on Indian Economy 

Fiscal deficit is an economic phenomenon, where the Government's total expenditure surpasses the revenue generated. It is the difference between the government's total receipts (excluding borrowing) and total expenditure. Fiscal deficit gives the signal to the government about the total borrowing requirements from all sources.
 
India’s fiscal deficit stands at 5.8percent of GDP in financial year 2011-12, worst among major emerging economies. According to the controller general of accounts, the deficit stood at Rs 509,731 crore in 2011-12. The fiscal deficit for the current year (2012-12) is projected to be contained at 5.1percent but analysts have already begun doubting if this could indeed be achieved given the economic slowdown. 
 
Although India boasts of still-robust economic growth of 6.5% in 2011-12, second only to China and much better than advanced nations, its performance on the fiscal front is far from satisfactory when compared to major emerging nations. In April, IMF projected India's consolidated fiscal deficit at 8.7% of GDP during 2011, which is expected to remain over 8% in 2012 and 2013. Though IMF's calculations will not tally with India's consolidated deficit of centre and states, it paints a gloomy picture of the government finances.
 
Widening of fiscal deficit is direct consequence of faster increase in government expenditure than that of the revenues. With the slowdown in post sub-prime crisis years, increase in government revenues also slowed down. However, expenditure could not be reduced due to social, economic and political compulsions. Social compulsions include expenditure on health, education; political compulsions include increasing subsidy bills on petroleum, power etc and financing ailing public sector units becomes the part of economic compulsions.
 
High fiscal deficits typically cause three problems — a balance of payments crisis, high interest rates (because of crowding out) and high inflation (with currency depreciation being a key contributor).
 
More that optimum level of fiscal deficit is going to affect the growth prospects of the country also. During 2004-08, high investment rates have been a crucial factor in India's growth rate rising to 9 percent.
 
The biggest concern about the slow pace of fiscal consolidation is that it will erode the savings rate and, hence, the rate of investment. High investment rates have been a crucial factor in India's growth rate rising to 9% in 2004-08. In the period following 2008, the investment rate has averaged 35% despite declines in the savings rate. This is because a wider savings-investment gap has been bridged by foreign flows and shows up as a higher current account deficit. 
 
Whereas the current account deficit (CAD) was 0.4-1.3 percent of GDP in 2005-08, it rose to 2.8percent in 2009-10 and 2010-11. There is broad agreement that a CAD of 2.5-3 percent of GDP is manageable for India. Taking the lower end of the range, it would mean that the economy can tolerate a CAD that is 1.2-2.1 percent higher than in 2005-08. A decline in the domestic savings rate of this order, caused by a higher fiscal deficit, can be made good through foreign inflows. However, as of now, since foreign investments are on decline, it may impact the growth negatively.
 
The Thirteenth Finance Commission target for the Centre's debt-to- GDP ratio of 45% by 2014-15 is expected to be met in 2012-13 itself. Secondly, high fiscal deficits can fuel inflation that dampens investor sentiment. Since fiscal consolidation will not happen as planned earlier, inflation is likely to remain above the Reserve Bank of India's (RBI) comfort zone of 5 percent.
 
It needs to be grasped that a high rate of inflation per se is not a problem. It is variability in the rate of inflation that is the problem as economic agents are then faced with uncertainty. The worry when inflation rate touches double digits is that policymakers have lost control over it, so it can shoot up even further. However, if the RBI can demonstrate that it can contain inflation at 6-7 percent, growth need not be derailed.
 
The Budget's Medium-Term Fiscal Policy Framework envisages a fiscal deficit-to-GDP ratio of 3.9% by 2014-15. The Thirteenth Finance Commission (TFC) had wanted the ratio to come down to 3%, the target set by the FRBM Act. Since high fiscal deficit means increased government borrowings. Borrowings from the RBI fuels inflation and borrowings from the market crowd out private sector by increasing the interest rate. In order to relate high fiscal deficit to inflation, some economists believe that the portion of fiscal deficit, which is financed by obtaining funds from the Reserve Bank of India, directs to rise in the money stock and a higher money stock eventually heads towards inflation.
 
Financial advisors recommend that the Government should not promote disinvestment to reduce fiscal deficits. Fiscal deficit can be reduced by bringing up revenues or by lowering expenditure. However, fiscal deficit reduction may have an impact over the agricultural sector and social sector.
 
International investors and credit rating agencies also attach a significant weight to the fiscal deficit when deciding on investing in a country or giving a sovereign rating. If the fiscal situation of a country deteriorates, international investors give a low rating to the country. Thus not just for domestic reasons, but to increase the flow of foreign inflows also, fiscal deficit needed to be curbed.
 
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