Fiscal Deficit

Topics: Public finance, Economics, Keynesian economics Pages: 9 (2573 words) Published: February 5, 2011
Fiscal deficit

In a system of indicative planning reliance, fiscal policy plays an instrumental role in the economy of any country. Planning Commission of India had pointed out in the Seventh Five Year Plan that, the “Fiscal policy has a multi-dimensional role” which “particularly aims at improving the growth performance of the economy and ensuring social justice to the people. However, when a fiscal policy is not used discreetly, it is likely to create a fiscal mess.....A fiscal imbalance requires immediate corrective measures because a large fiscal deficit is non-sustainable.”

The Emergence of Fiscal deficit (or Budget Deficit):

On account of growing burden of non-development expenditure, the fiscal situation deteriorated throughout the 1980s and assumed crisis proportions by the beginning of 1991-92. Throughout the 1980s all the major indicators of fiscal imbalance largely reflected that it was on the rise. Following the US budgetary practices the concept of fiscal deficit has come into use in India:

It is the difference between the total government expenditure over government revenue thus reflects the total resource gap. This measure has been also adopted by the IMF as the principle policy target in the evaluating the performance of countries seeking assistance.

According to Reserve Bank of India, Fiscal Deficit is the difference between aggregate disbursements net of debt repayments and recovery of loans and revenue receipts and non-debt capital receipts.

Thus, we can say that Fiscal deficit or budget deficit is an economic phenomenon, where the Government's total expenditure surpasses the revenue generated. It is the difference between the government's total receipts (excluding borrowing) and total expenditure.

In simple terms, it is the difference between what the government earns and what it spends. Normally it is described as a percentage of GDP. The government accumulates this amount by currency emission or borrows the amount in order to compensate for the shortage or deficit in tax revenues. Thus, if a country is sending more money overseas than it is bringing in, it has a budget deficit. Fiscal deficit is an indication of the total borrowings needed by the government. While calculating the total revenue, borrowings are not included. Generally fiscal deficit takes place due to either revenue deficit or a major hike in capital expenditure. Capital expenditure is incurred to create long-term assets such as factories, buildings and other development. A deficit is usually financed through borrowing from either the central bank of the country or raising money from capital markets by issuing different instruments like treasury bills and bonds.

In the Indian context, budget deficit is the difference between the total expenditure and current revenue and net internal and external capital receipts of the government. It is financed by external capital and net internal receipts. However, the monetization of such debts can lead to inflation. Another way by which a government attempts to recover its deficit is by selling of its assets. The state of fiscal deficit is viewed from two different perspectives. Conventionally it is believed that such a deficit should be avoided in order to project a well balanced budget policy. On the other hand, economists like John Maynard Keynes are of the view that a fiscal deficit can bring a country out of a state of economic slump or recession. But, it is believed that government needs to avoid deficits to maintain a balanced budget policy.

According to Keynesian economic theories, running a fiscal deficit and increasing government debt can initially stimulate economic activity only when a country's output (GDP) is below its potential output. But when an economy is running near or at its potential level of output, fiscal deficits can cause high inflation. At that point fiscal deficit must be controlled.

Components of fiscal deficit

The primary component of...
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