DH Deciphers | What is a fiscal deficit? How does it affect the government and the public?

Fiscal deficit is one of the most important financial terms when we talk about government budgets. Governments all over the world are obsessed about reducing the fiscal deficit because it's a clear indication of how well they are managing their finances. But reducing the fiscal deficit is easier said than done especially when the economy isn't doing well, as is the case during these times of the coronavirus. So let's take a look at the fiscal deficit, how does it affect the government and whether it would affect us.

What is a fiscal deficit and how is it calculated?

The word fiscal means relating to government money while deficit means a shortfall. A fiscal deficit is the gap in a government's income and spending. Simply put, the government has a fiscal deficit when it is spending beyond what it earns by way of tax or non-tax revenues. A fiscal deficit is calculated as a percentage of the gross domestic product (GDP) in a financial year and doesn't include the money that the government borrows from financial institutions. Since India has a federal structure, the fiscal deficit is calculated both in terms of the central government and the state governments.

What was the fiscal deficit last year? What will it be this year?

The union budget for 2019-20 had aimed to restrict the fiscal deficit to 3.3% of the GDP but the government missed the target (remember the GST collections were down?). The target was then revised to 3.8% but still could not be achieved. The fiscal deficit stood at 5.07% between April 2019 and February 2020. The final number for the whole financial year isn't out yet but it will be way off the mark.

The 2020-21 budget then set out to keep the fiscal deficit to 3.5% but this target already looks impossible to achieve because of the Covid-induced lockdown. Economists forecast that the central government's fiscal deficit will reach 8% of the GDP as it will borrow more to deal with the pandemic and the fiscal stimulus of Rs 20.8 lakh crore. The government wants to spur spending by giving more money to people who can then buy and invest more. The Centre and the state governments are projected to have a combined fiscal deficit of 12% of the GDP this financial year.

Where does the government get the money to finance the fiscal deficit?

The government issues securities and treasury bills to borrow from the financial markets. Government securities are essentially bonds that earn interest. Treasury bills are government bonds or debt securities with maturity of less than a year. But borrowing more creates many problems for the government.

What are those problems?

When the government borrows a lot from public savings, it pushes out the private sector, which also needs to borrow in order to run businesses. Then begins a competition between the government and the private sector, pushing up the interest rates on loans. The private sector doesn't feel like investing, and the economy suffers. Also, higher borrowing today means a greater payout of taxes in the future, which punishes the next generation. A high fiscal deficit also triggers the possibility of current account deficit (the shortfall between a country's exports and imports) and raises public debt and inflation.

Global investors and rating agencies keep an eye on the fiscal deficit. Investors also monitor this sacrosanct figure as they use it to judge the health of the economy before making any investment decision. Rating agencies watch it to pronounce their outlook, which often determines the volume of investment flows into the domestic economy and markets.

What happens when the govt fails to cut the fiscal deficit?

It resorts to off-budget financing and other tricks such as rolling over certain payments to the next year in order to hide the reality. The off-budget financings, such as the borrowings from the Food Corporation of India and the small savings, do not form part of the union budget and are not subject to parliamentary scrutiny. But these cost taxpayers and the economy even more.

Now that COVID-19 will jack up the fiscal deficit, what's the way out?

The government may monetise its borrowings to avert the risk of interest rates shooting up. Monetisation is nothing but the Reserve Bank of India (RBI) buying government bonds by printing more money.