02 Jun 2023 FISCAL DEFICIT
This article covers “Daily Current Affairs” and the topic details “Fiscal Deficit”. The topic “Fiscal Deficit” has relevance in the Economy section of the UPSC CSE exam.
Relevance:
For Prelims:
What is Fiscal Deficit?
For Mains:
GS 3: Economy
Causes of Fiscal Deficit?
Impact of High Fiscal Deficit?
Measures to reel in a high Fiscal Deficit?
Why in the news?
India’s Financial Year 23 fiscal deficit narrows to 6.4% of the GDP, meets budgeted target
What is Fiscal Deficit?
Fiscal deficit refers to the difference between a government’s total expenditures and its total revenue (excluding borrowing) during a particular fiscal year. It represents the amount of money the government needs to borrow to meet its expenditure requirements when its expenses exceed its revenue.
Fiscal Deficit = Total Expenditure (Revenue Expenditure + Capital Expenditure) – (Revenue Receipts + Recoveries of Loans + Other Capital Receipts (all Revenue and Capital Receipts except loans taken))
In simpler terms, the fiscal deficit indicates the extent to which a government needs to rely on borrowing to fund its spending commitments. It is an essential measure of a government’s fiscal health and indicates the extent to which a government is spending more than it is earning through tax revenues and other sources
Fiscal deficit is typically expressed as a percentage of a country’s Gross Domestic Product (GDP). It is an important indicator of a government’s fiscal prudence and can have significant implications for the overall economy.
Causes of Fiscal Deficit?
- Insufficient revenue generation: One of the primary causes of fiscal deficits is when a government fails to generate enough revenue to cover its expenditure commitments. This can occur due to factors such as low tax compliance, tax evasion, inefficient tax administration, narrow tax base, or an economic slowdown leading to reduced tax collections.
- High expenditure commitments: Governments may face fiscal deficits if their expenditure commitments are high relative to their revenue. This can result from various factors, including high spending on social welfare programs, subsidies, defense, infrastructure development, public sector salaries, and pensions. Unplanned or uncontrolled spending can contribute to a widening fiscal deficit.
- Economic downturns and recessions: During periods of economic downturns or recessions, governments may experience decreased tax revenues due to reduced economic activity. At the same time, they may face increased spending pressures due to countercyclical measures, such as stimulus packages, unemployment benefits, and support to struggling sectors. These factors can contribute to fiscal deficits.
- Interest payments on past borrowings: Governments that have accumulated significant debt in the past may have to allocate a substantial portion of their budget to service the interest payments on that debt. High interest payments can put strain on government finances and contribute to fiscal deficits, particularly if revenue generation is insufficient to cover these expenses.
- Structural issues and inefficiencies: Structural issues within the economy, such as a large informal sector, tax leakages, or inefficiencies in public spending, can contribute to fiscal deficits. Inefficient use of resources, misallocation of funds, corruption, and poor governance can result in wasteful expenditures and inadequate revenue generation, leading to fiscal imbalances.
- Demographic factors and social obligations: Demographic factors, such as an aging population or a high dependency ratio, can put pressure on government finances. Increased healthcare and pension expenditures can strain the budget, especially if revenue generation does not keep pace with these obligations. Social obligations, such as education, healthcare, and poverty alleviation, can also contribute to fiscal deficits if funding is inadequate.
- External shocks and emergencies: External shocks, such as natural disasters, global economic crises, or geopolitical events, can have significant fiscal implications. Governments may need to increase spending for disaster relief, rehabilitation, or economic stabilization, which can lead to fiscal deficits if additional revenue sources are not available.
Impact of High Fiscal Deficit?
- Increased Government Borrowing: A high fiscal deficit indicates that the government needs to borrow more money to finance its expenditures. This can lead to an increase in government debt and interest payments, putting upward pressure on interest rates.
- Economic Instability: A persistent and high fiscal deficit can create macroeconomic instability. It can lead to inflationary pressures as the government injects more money into the economy through borrowing, increasing the money supply. This can erode purchasing power and reduce the value of the domestic currency. Inflation can have adverse effects on investment, savings, and overall economic growth.
- Reduced Private Investment: A high fiscal deficit can lead to higher interest rates and reduced availability of credit in the economy. This can discourage private investment as businesses face higher borrowing costs. Reduced private investment can hinder economic growth, limit job creation, and hamper productivity improvements.
- Crowding Out Effect: When the government needs to borrow extensively to cover the fiscal deficit, it competes with the private sector for available funds in the financial market. This can lead to a crowding out effect, where private businesses and individuals find it more difficult to access credit or face higher borrowing costs. Crowding out can hinder private investment and economic growth.
- Pressure on Exchange Rates: A high fiscal deficit can put pressure on the exchange rate of a country’s currency. If the deficit is financed through borrowing from external sources, it can increase external debt and raise concerns among foreign investors. This can lead to a depreciation of the domestic currency, making imports more expensive and potentially increasing inflationary pressures.
- Rating Downgrades and Investor Confidence: Persistently high fiscal deficits can erode investor confidence and lead to rating downgrades by credit rating agencies. Lower credit ratings can increase borrowing costs for the government and limit access to international capital markets. It can also deter foreign direct investment (FDI) and other forms of foreign investment, impacting overall economic growth.
Measures to reel in a high Fiscal Deficit?
- Expenditure Rationalization: Review and prioritize government expenditure to identify areas where spending can be reduced or optimized without compromising essential services. This can involve cutting down on non-essential expenditures, subsidies, and wasteful expenses.
- Public Sector Reforms: Undertake reforms to improve the efficiency and effectiveness of public sector organizations. This can include measures such as reducing bureaucracy, streamlining government agencies, and improving public procurement practices to reduce inefficiencies and control expenditure.
- Subsidy Reforms: Assess and reform existing subsidy programs to ensure that they are targeted to those who truly need them. Consider reducing subsidies for sectors that are not economically viable or have minimal social impact. Implement mechanisms to provide direct benefits to the intended beneficiaries instead of generalized subsidies.
- Tax Reforms: Evaluate the tax structure to identify areas for improvement and revenue enhancement. This can involve measures such as broadening the tax base, reducing tax evasion and avoidance, simplifying tax procedures, and exploring the possibility of introducing new taxes or adjusting tax rates to generate additional revenue.
- Fiscal Discipline: Implement strict fiscal discipline measures to control expenditure and enforce budgetary discipline. This can include introducing expenditure ceilings, improving financial management practices, and enhancing monitoring and control mechanisms to ensure adherence to budgetary targets.
- Public Asset Management: Optimize the utilization of public assets and explore avenues for monetization or divestment of non-strategic assets. This can help generate revenue and reduce the need for excessive borrowing to finance the fiscal deficit.
- Debt Management: Develop effective debt management strategies to optimize borrowing costs and minimize the burden of interest payments. This can involve refinancing high-cost debts, negotiating favorable borrowing terms, and exploring options for debt restructuring or rescheduling.
- Economic Growth and Revenue Enhancement: Focus on policies and measures that promote economic growth and increase revenue generation. This can include initiatives to attract investments, support entrepreneurship, boost exports, and stimulate economic activity, which can lead to higher tax revenues and reduce the fiscal deficit.
Q.1 Consider the following statements regarding fiscal deficit in India:
1: Fiscal deficit represents the excess of government expenditure over its total revenue and is equal to borrowing.
2: A low fiscal deficit can lead to inflationary pressures in the economy.
3: The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 aims to bring down the fiscal deficit to a sustainable level.
Select the correct statement(s) from the options given below:
(a)1 only
(b)1 and 2 only
(c)1 and 3 only
(d)1,2 and 3
Answer:(c)
Q.2 What is the potential impact of a high fiscal deficit on an economy?
(a) It can lead to inflationary pressures and erode the purchasing power of the currency.
(b) It encourages private investment and stimulates economic growth.
(c) It reduces the burden of public debt and improves credit ratings.
(d) It has no significant impact on the overall economy.
Answer: (a)
Q.3 Examine the concept of fiscal deficit and its implications on the economy of a country. Discuss the factors contributing to the fiscal deficit and suggest measures to effectively manage it.
Yojna ias daily current affairs eng med 2nd June 2023
No Comments