Fiscal Deficit: Underlying reasons and Road ahead for India: Civil Services Mentor Magazine - July 2014

Fiscal Deficit: Underlying reasons and Road ahead for India

'Fiscal Deficit' might be a word many people today are using without even realizing what it means or how significant it is. 'Fiscal Deficit' is actually when a government's total expenditures exceed the revenue that has been generated. The fiscal deficit, was 4.9 per cent of GDP in the previous financial year.

Fiscal deficit is possibly the most crucial issue in the global financial markets these days and one of the most daunting tasks that Government of few particular countries have to face while taking care of it's economy. For instance, the euro zone is under constant threat of falling apart because of large accumulated debt and high fiscal deficit in a number of countries, lawmakers in the US do not give any consent on deficit reduction plan. Indian scenario not very different; however, things seem to be turning up for better.

Fiscal Deficit: different perspectives

Keynesian view, favors huge expenditure by the government to employ available resources to the fullest. On the other hand , argument of Ricardian is that it doesn't make a difference as consumers cut expenditure in anticipation of higher taxes that will be levied later in order to pay off the debt. Neo-classical school of thought, on the other hand has been a dominating view on the subject and the neo-classical economists argue that high government expenditure and savings have a negative co-relation and it affects growth adversely.

The financing of budgets by deficits implies postponement of taxes. The deficit in any current period is exactly equal to the present value of future taxation that is required to pay off the increment to debt resulting from the deficit. In other words, government spending must be paid for, whether now or later, and the present value of spending must be equal to the present value of tax and non-tax revenues.

The Indian scenario

The ill effects of running high deficit has always been far more visible in India . There is a threat of ratings downgrade, high fiscal deficit is the source of most of the problems that the Indian economy is facing today. Fiscal deficit in India for 2013-14 fiscal is most likely to be in the range of 5 - 5.1 per cent of the GDP. High levels of fiscal deficit relative to GDP tend not only to cause sharp increases in the debt-GDP ratio, but also adversely affect savings and investment, and consequently growth.

In the interim budget it was aimed that in 2013-14 fiscal deficit would be contained at 4.6 per cent of GDP. Mr. Chidambaram had drawn up a financial consolidation road map to lower the fiscal deficit to 4.8 per cent of GDP in 2013-14, 4.2 per cent in 2014-15 and 3.6 per cent in 2015-16.

The surge of fiscal deficit in the past couple of years can largely be attributed to both slower revenue growth and higher expenditure growth in context of India.

World Scenario

As already mentioned before, a deficit occurs when the outlays of a government exceed the inlays and a surplus is when revenues are higher than expenditure. This ratio is usually presented as a percent of gross domestic product (GDP). Most countries from OECD in the time - period 1990 - 2006 have had deficits; however by 2007 , they emerged from it and started making surplus. Alas, as a result of the Great Recession of 2007-2008, budget shortfalls were on the loose again by 2009. Come 2012 and the deficit of OCED grew to 5.5%. The situation is now improving , thanks to the dedicated efforts of fiscal consolidation by governments across Europe in particular. In fact, total deficit in OECD countries is expected to decrease to 3.6% by end of 2014.

In the Great recession (between 1932-1936) the United States operated deficits averaging 4.8 percent of GDP. The experience of the Great Recession teaches us not how to bring recession deficits under control but the need to ensure that deficits are sufficiently large to stimulate economic recovery during a serious downturn. At a ridiculously high 22.2 percent of GDP, the World War II deficits of FY1942-1945 makes seem deficit of recent times as nothing, but at that time, fiscal recovery was also more rapid than is possible in current circumstances. Without proper reform and enhancement of revenue , the United States is staring into a fiscal void. Adding to America's problems, it has become increasingly dependent on foreign central banks, especially China's, in order to finance government debt.

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