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CONCEPT OF DEFICITS

By :    July 23, 2019

A budget can be a balance budget, surplus budget or a deficit budget on revenue account. The Union Budget every year projects four deficits viz., revenue deficit, fiscal deficit, primary deficit and effective revenue deficit. It may also project monetised deficit which reflects borrowing from the RBI.

Various deficits that appear in Union Budget are defined as follows: Revenue Deficit – Revenue Expenditure – Revenue Receipts

This deficit implies what the government spends on a day to day basis (i.e. on revenue account) and what the government earns on a day-to-day basis. The day-to-day expenditure of the government on revenue account invariably has been in excess of its day-to-day receipts causing a serious problem of high revenue deficit year after year. This deficit is in effect deficit on account of fast rising non-plan and consumption expenditure of the government for which government resorts to market borrowing which results in high fiscal deficit. The key to reduce fiscal deficit is to reduce revenue deficit first.

Effective Revenue Deficit: This concept was introduced in the Union Budget 2012-13. Effective Revenue Deficit = Revenue Deficit – Grants given to States for creation of capital assets. These grants are shown in the revenue expenditure of the government.

Fiscal Deficit = Total Expenditure – Revenue Receipts + non-financial liability or non-debt imposing capital receipts (grants, recoveries of past loans, proceeds of sales of assets, divestment proceeds)

The concept of fiscal deficit assumes great significance as it indicates the level of overall borrowings of the government. The target for fiscal deficit for 2014-15 placed at 4.1 percent of GDP but alarmingly, fiscal deficit shot up to 99 percent of its full year target between April and November, 2014 due to lower tax revenues, higher tax refunds and collections from other sources lower than expected. The Finance Ministry, in its mid­year economic analysis conceded that the fiscal deficit target of 4.1 percent was over ambitious.

Primary Deficit = Fiscal Deficit- Interest Payments

Primary deficit shows what government’s fiscal deficit would have been if there was no burden of interest payments on past loans. A low primary deficit means that most of the fiscal deficit is on account of interest payments.

If this deficit is negative, it means that the entire fiscal deficit is on account of interest payments on past loans.

Monetised Deficit = Net increase in the RBI credit to the government which is financed by printing fresh currency. This implies deficit which may be plugged by borrowing from the RBI and not from banks. In this case, RBI prints fresh currency to finance borrowings of the government.

There are three ways in which a high fiscal deficit can be plugged and financed viz, borrowing from RBI, borrowing from Commercial Banks and borrowing from external sources. Each of these three modes of financing has its own problems for the economy. For example, if the deficit is financed from the RBI, it may lead to excess money supply in the economy which is a potential source of inflation.

High inflation makes exports non-competitive and encourages imports. Thus, a high fiscal deficit can spill over into a high current account deficit which puts downward pressure on the exchange rate. High inflation is one of the reasons of high CAD (Current Account Deficit) in recent years. On the other hand, too much borrowing from non-RBI domestic sources, such as banks, other financial institutions and individuals, is likely to drive up interest rates. Excessive government borrowing from non-RBI domestic sources is likely to soak up investible funds which would have otherwise financed production and investment in industry, agriculture, infrastructure etc. This in fact “crowds-out” private investment and thus lowers the growth of output and employment. Similarly, excessive foreign borrowings to finance high fiscal deficits can create external payment problems and problems of servicing of the external debt.

Fiscal consolidation is necessary for containing inflation, reducing interest rates, promoting investment and growth, and fostering reasonable stability in the financial system and the foreign exchange market. More than the fiscal deficit, it is the quality of fiscal deficit and government expenditure and the nature of the tax system underpinning the fiscal system which is important. If the fiscal deficit is on account of more and more capital expenditure, then one may not worry too much because this capital expenditure in due course would start generating economic returns to cover up this deficit. However, if the fiscal deficit is largely on account of low priority revenue expenditure, as is the case in India, then the fiscal situation really becomes unsustainable. These low priority expenditures and non-targeted subsidies lead to a high revenue deficit and need to be identified and eliminated. Fiscal sustainability calls for reforming the tax system to augment revenue mobilisation and containing expenditure by downsizing the government and by reducing a large amount of wasteful expenditure. The fiscal situation in India causes concern from time to time due to the inability of the government to check its wasteful expenditure particularly non-plan expenditure. There are many dimensions on which quality of fiscal deficit can be assessed.

One is the lag between fiscal action and increase in effective demand. Another is the degree to which the medium term productivity of the economy is increased. Expenditure such as debt relief, which has short lags, may have little or no effect on productivity, while productive infrastructure expenditure takes much longer to translate into effective demand.

The most worrisome aspect of the Centre’s fiscal deficit is that nearly three fourth of the borrowings are used for financing unproductive revenue expenditure. This adds to the already high interest burden of the government and threatens a situation of debt trap, in order to bring about fiscal consolidation and restore the fiscal health of the economy, some significant measures have been taken in the last few years. These include reduction of food and fertiliser subsidy, reduction of interest rates on provident fund and small savings including those of Post Offices, downsizing/right sizing the government, introduction of Zero Based Budgeting, limiting fresh government recruitment to minimum essential needs, review of the entire subsidy regime with a view to bringing in more and more of cost-based user charges, acceleration of the privatisation process, implementation of the recommendations of the Expenditure Reforms Commission in respect of abolition of the identified surplus manpower, limiting fresh recruitment to 1 percent of the total civilian staff strength and offering VRS packages, apart from other recommendations. Most importantly, the government sought to discipline itself by enacting FRBM Act in 2003 and follow the rules laid down under the Act. These rules are:

  1. Reduction of revenue deficit by an amount equivalent of 0.5 percent or more of the GDP at the end of each financial year, beginning with 2004-2005.
  2. Reduction of fiscal deficit by an amount equivalent of 0.3 percent or more of the GDP at the end of each financial year, beginning with 2004-2005.
  3. No assumption of additional liabilities (including external debt at current exchange rate) in excess of 9 percent of GDP for the financial year 2004-2005 and progressive reduction of this limit by at least one percentage point of GDP in each subsequent year.
  4. No guarantees in excess of 0.5 percent of GDP in any financial year, beginning with 2004-2005.
  5. Specifies four fiscal indicators to be projected in the medium term fiscal policy statement, which are,
  • revenue deficit as a percentage of GDP
  • fiscal deficit as a percentage of GDP
  • tax revenue as a percentage of GDP, and
  • total outstanding liabilities as a percentage of GDP.
  1. For greater transparency in the budgetary process, rules mandate the Central Government to disclose changes, if any, in accounting standards, policies and practices that have a bearing on the fiscal indicator. The Government is also mandated to submit statements of receivables and guarantees and “a statement of assets, at the time of presenting the annual financial statement.
  2. The rules prescribe the form for the quarterly review of the trends of receipts and expenditures. The rules mandate the Central Government to take appropriate corrective action in case of revenue and fiscal deficits exceeding 45 percent of the budget estimates, or total non-debt receipts falling short of 40 percent of the budget estimates at the end of first half of the financial year.

The FRBM Act has been amended in 2012-13 as mentioned in the preceding section.

Task Force on Implementation of FRBM Act

Following the enactment of FRBM Act, Government constituted a Task Force headed by Dr. Vijay Kelkar for drawing up the medium term framework for fiscal policies to achieve the FRBM targets. The Task Force was also asked to formulate annual targets indicating the path of adjustment and required policy measures. The Task Force submitted its report in July, 2004. The Task Force recommended a path of fiscal adjustment that is front-loaded and mainly revenue-led, with complementary reform efforts on revenue expenditure and enhanced capital expenditure to counteract the possible contractionary effects of fiscal correction.

The Task Force inter alia proposed the introduction of an All-India goods and services tax (GST), on the basis of a ‘grand bargain’ with States, whereby States will have the concurrent powers to tax services, subject, to certain principles that will help foster a national common market. It also proposed changes in income tax, corporate tax, excise duty and custom duty structure. Some of these changes have since been incorporated.

Tags : Concept of DeficitFiscal deficitFRBM ActMonetised deficitPrimary deficitTypes of Deficit

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