Fiscal Deficit is an economic phenomenon, where the government’s total expenditure surpasses the revenue generated. It is the difference between government's total receipts (excluding borrowing) and total expenditure. Fiscal deficit gives the signal to the government about the total borrowing requirements from all sources.
The primary component of fiscal deficit includes - revenue deficit and capital expenditure.
The capital Expenditure is the fund used by an establishment to produce physical assets like property, equipments or industrial buildings. Capital expenditure is made by the establishment to consistently maintain the operational activities.
In India, the fiscal deficit is financed by obtaining funds from Reserve Bank of India, called deficit financing. The fiscal deficit is also financed by obtaining funds from the money market (primarily from banks).
Why Fiscal Deficit creates problem for the economy of the country?
According to the view of renowned economist John Maynard Keynes, fiscal deficits facilitate nations to escape from economic recession.
From another point of view, 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.
In order to relate high fiscal deficit to inflation, some economists believe that the portion of fiscal deficit, which is financed by obtaining funds from the Reserve Bank of India, directs to rise in the money stock and a higher money stock eventually heads towards inflation.
Trends in the Fiscal Deficits of India in past few years –
The fiscal deficit of the Central Government has improved substantially from 5.9% of GDP in 2002-03 to 2.7% in 2007-08.
The revenue deficit of the Central Government declined from 4.4% of GDP to 1.1% during the same period.
In conformity with the fiscal restructuring recommended by Fiscal Responsibility and Budget Management Act - FRBM, the fiscal deficit is required to be contained within 3 % of GDP for the Centre and 3% of GSDP for each of the State governments, which have enacted FRBM legislation.
All the State governments except for West Bengal and Sikkim have enacted FRBM legislation. This has resulted in substantial improvement in both Gross Fiscal Deficit and Revenue Deficit during the Tenth Plan.
The combined fiscal deficit of the Centre and the States declined from 9.6% of GDP in 2002-03 to 5.6% in 2006-07, and further to 5.3% in 2007-08.
The fiscal deficit of both Centre and States increased substantially in the year 2008-09 due to the fiscal stimulus provided in the context of economic slowdown. The stimulus pushed the fiscal deficit and revenue deficit of the Central government up to 6.2% and 4.5% of GDP respectively in 2008-09 (RE).
GFD for the Centre alone estimated to be 6.2 percent of GDP at the RE (Revised Estimates) stage compared to 2.5 percent of GDP at BE (Budget Estimates) stage in the year 2008-09. The combined revenue deficit of the Centre and States declined from 6.6% of GDP in 2002-03 to 1.3% in 2006-07 and further to 0.9% in 2007-08.
In the year 2008-09, revenue deficit of Centre was estimated to increase to 4.45 per cent of GDP (RE) as against 1.5% at BE stage. Fiscal stimulus allows the states to borrow over and above the FRBM limit to the extent of 0.5% of GSDP.
The fiscal consolidation effort by the State governments along with implementation of Twelfth Finance Commission (TFC) award improved the fiscal deficit of the States from – 4.1% of GDP in 2002-03 to 2.3% in 2007-08 (RE) and further to 2.1% in 2008-09 (BE).