Introduction

You have probably heard the term fiscal deficit often in the news, especially when the government announces its annual budget. But what does it actually mean? How is it calculated? And why does it matter for the economy and society?

Let’s discuss it all here.

Fiscal Deficit Meaning

A fiscal deficit arises when the government's total spending exceeds its revenue in a specific fiscal year. It indicates how much the government spends beyond its income and how much it needs to borrow to finance its activities.

The fiscal deficit is determined by calculating a percentage of the GDP, which represents the value of the overall goods and services produced within the economy annually. The fiscal deficit formula is outlined below:

Fiscal Deficit = {(Total Expenditure – Total Revenue) ÷ GDP}

Here,

• Total expenditures include capital expenditures (such as infrastructure, machinery, and equipment) and revenue expenditures (such as salaries, pensions, subsidies, and interest payments).
• Total revenue includes tax revenue (income tax, corporate tax, and GST) and non-tax revenue (such as dividends, fees, and fines).

For example, if the government spends Rs 10,000 crore and earns Rs 8,000 crore in a year, the fiscal deficit is Rs 2,000 crore. That means the government must borrow Rs 2,000 crore from the market or other sources to finance its spending.

Causes of Fiscal Deficit

Many factors can lead to fiscal deficit, such as:

• Revenue shortfall:  This happens when the government fails to collect enough revenue from taxes and other sources for various reasons, such as tax evasion, tax exemptions, tax cuts, a low tax base, etc.
• Expenditure overshooting:  This scenario occurs when the government spends more than it planned or budgeted for various reasons, such as unplanned subsidies, wage hikes, defence spending, natural disasters, and wars.
• Economic slowdown:  The country faces this situation when the economy grows slower than expected. This could be due to various reasons, such as demand shocks, supply shocks, policy errors, external shocks, etc. This reduces the government's revenue and increases its expenditures as it tries to spur the economy and relieve the affected sectors and people.
• Natural disasters:  When the country is hit by unforeseen events, such as floods, droughts, earthquakes, pandemics, etc., major economic disruption occurs. Natural disasters impact ongoing developmental plans and damage infrastructure, requiring the government to spend more on rescue, relief, and reconstruction.

Effects of Fiscal Deficit

The fiscal deficit effect depends on its size, duration, and composition. Some of the effects of fiscal deficit are:

• Growth:  Fiscal deficits can have a positive effect on growth if they are used to finance productive and growth-enhancing expenditures, such as infrastructure, education, health, etc. This can generate a multiplier effect on income and output. However, they can negatively affect growth when used to finance unproductive and wasteful expenditures like interest payments on borrowing that were not necessary.
• Inflation:  Fiscal deficit can positively affect inflation if it is moderate and countercyclical, meaning it is lower during boom periods and higher during recession periods. This can help stabilise the price level and maintain the purchasing power of money. Nevertheless, when it is excessive and aligned with the economic cycle, it can hurt inflation. This can lead to overheating of the economy and erosion of the value of money.
• Interest rates:  The impact of fiscal deficit on interest rates depends on how the government finances it. If the government uses non-inflationary sources of funds, such as foreign loans or privatisation proceeds, it can lower the interest rates and boost the demand for investment and consumption. On the other hand, if the government resorts to inflationary sources of funds, such as printing money or borrowing domestically, it can raise interest rates and reduce the demand for investment and consumption.
• Social welfare:  Suppose the government uses the deficit to fund social welfare schemes, such as health, education, and poverty alleviation. In that case, it can enhance the human capital and social security of the people and lower the inequality and poverty in society. However, suppose the government uses the deficit to fund non-social welfare programs, such as defence, interest payments, etc.. In that case, it can reduce the availability and quality of funds for social welfare programs.

Conclusion

The fiscal deficit has positive and negative impacts on the economy and society. The overall outcome of the fiscal deficit depends on how the short-term and long-term effects balance out and the ideal amount and type of fiscal deficit.

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