04 February 2021

Eco Basics: Dangerous Effects of High Fiscal Deficit

This post will focus on the negative consequences of a high Fiscal Deficit.

Before that, let me address a pertinent question: Where does the Government of India borrow from?

The three major sources of borrowing for the Government of India are (a) RBI, (b) foreign lenders (sovereign governments and international organizations like IMF and World Bank), and (c) from the general public of our country.

Contrary to popular perception, the Government of India borrows most from the general public, through the issue of bonds (pretty much like fixed deposits).

What are the adverse consequences of Fiscal Deficit?

A high Fiscal Deficit is bad for the general state of the economy, foreign trade balance, and currency exchange rate.

Rising Interest Rates

A high Fiscal Deficit means the Government of India’s (GOI, or just government) borrowings are high. When the government borrows money from the general public, it creates demand for money. 

Lending to government carries zero risk, as the government would not default on repayment (it has not defaulted till date!). However, greater government borrowing would mean less money is available for lending to industrial and other sectors of the economy. This would push up interest rates for the borrowers from the industry and other sectors of the economy.

Reduced Business & Economic Activity

Higher interest rates would add to overall cost of production, thereby increasing the cost of operations. This in turn would render business activity, like increased production and expanding operations, unviable. Hence, a lot of businesspersons would opt out of such economic activity as they no longer find it profitable.

Reduced Income & Employment Generation

If due to higher interest rates businesspersons opt out of economic activity (or close down plants), it would lead to reduction in employment generation. This would in turn mean that the retrenched (those thrown out of jobs) and the unemployed do not earn income, thus reducing their purchasing power.

If purchasing power goes down, then their aggregate demand for goods and services would also go down. This in turn would also reduce industrial activity, thereby depressing overall economic scenario.

Lowers Exchange Rate & Increases Trade Deficit

Sometimes the government of India would borrow from foreign sources. When the government is lent money, foreign exchange comes into the economy. This would increase the supply of the foreign currency, which in turn would be exchanged for the Indian rupee.

The rise in demand for the Indian currency would increase its value. Simply put, as foreign entities begin to exchange their currency for Indian rupee, the value of the Indian rupee will also increase.

For example, the exchange value of the Indian rupee for each U.S. dollar is 72. In this scenario, let’s say, when a foreign entity is exchanging its currency for Indian rupee in large volumes, the exchange value may fall to 70 per U.S. dollar.

This means that while earlier one U.S. dollar would have fetched 72, now it would fetch only 70. This would hurt exports and encourage imports. 


As an importer, in the past, you were paying 72 per U.S dollar of import while now you are paying only 70. This means that your cost of operations would also fall.

However, if you are an exporter, then this would mean that you would earn less from your exports; like earlier you were earning 72 for every U.S. dollar of export, it is only 70!

If exports go down and imports go up, the country's trade deficit would rise. 

Also, high borrowings now would mean that the country's financial position becomes precarious as it piles higher debt and interest burden on future generations. 

In short, a high Fiscal Deficit is dangerous in every way possible: for general economic activity, employment generation, exchange rate, and trade balance.

02 February 2021

Eco Basics: Understanding Fiscal Deficit


Today's article focuses on Fiscal Deficit.

What types of receipts are non-debt creating?
Revenue Receipts, Recoveries of Loans, and Other Receipts are all non-debt creating. This means that the government does not have to borrow to generate these sources of income.

Now, look at the accompanying table: Fiscal Deficit is numbered 22, Revenue Receipts is 1, Recoveries of Loans is 5 and Other Receipts is numbered 6.

(22) Fiscal Deficit = (16) Total Expenditure – [(1) Revenue receipts + (5) Recoveries of loans + (6) Other Receipts]

Revenue Receipts
 would include both tax and non-tax revenue of the Government of India (GoI).

What is tax revenue?
This refers to revenue that the GoI gets by way of collecting taxes, like Personal Income Tax, Corporate Tax (charged on incomes of companies), Central Sales Tax and Service Tax.

What is Non-tax revenue? 
This would include Stamp Duty and Dividends earned from Public Sector Units (PSUs). Dividend is the return on capital invested by the government in PSUs.

Sometimes the Government of India receives money that it would have lent to some country/organization in the past. When such money is received, it is recorded under the ‘Recoveries of Loans’ head.

When does Fiscal Deficit arise?
Fiscal Deficit arises when the government has expenditure higher than the revenue it generates. To bridge this expenditure-revenue deficit, the government resorts to borrowing. This borrowing is called Fiscal Deficit.

In short, fiscal Deficit is the total borrowing of the Government of India to fund the allocations and expenditures listed in the Union Budget.

In the table above, the Budget Estimate for Fiscal Deficit for 2020-21 (total borrowing) was projected at Rs7,96,337 crore. But the economic ravage brought about by the Covid pandemic destroyed major sources of tax and non-tax revenues. 

The shortfall in Gross Tax Revenue (includes GST, Income Tax, Corporation Tax and other taxes) was Rs5,22,740 crore. The projected figure for Gross Tax Revenue in 2020-21 was Rs24,23,020 crore, but the Central Government could collect only Rs19,00,280 crore. 

So, the Revised Estimates for 202021 show a Fiscal Deficit of Rs18,48,655 croreIn other words, what this figure means is that the Government of India is borrowing this huge amount of money in 2020-21! Yes, you got it right: a total borrowing of mind-numbing Rs18.48 lakh crore in one year!

Fiscal Deficit is usually expressed in terms of percentage of the country’s Gross Domestic Product (GDP).

Now, go to the bottom of the table. It is mentioned that India’s GDP in 2020-21 will be Rs194,81,975 crore (Rs194.8 lakh crore).

Taking India’s GDP to be Rs194,81,975 crore in 2020-21, the Fiscal Deficit of Rs18,48,655 crore works out to 9.5% of GDP.

So, to say that we are living way beyond our means would be an understatement. However, given the Covid pandemic-induced shutdown there was little elbow room for the Central Government to raise revenue and hence, it had to resort to very heavy borrowings to fund its welfare schemes. like providing free food grains and direct cash transfer to millions of heavily impacted vulnerable sections of the society. 

In the next post, I will write on how a high Fiscal Deficit could spell doom for the economic growth of the country.