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. 

How?

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.

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.

Hence,

(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 2020–21 show a Fiscal Deficit of Rs18,48,655 crore. In 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. 

Eco Basics: What is the Economic Survey?

In India, there is hardly any economic event that captures popular imagination as much as the Union Budget. In this Budget series, The Explainer will focus on the complex budget jargon that puts off even 'interested-in-budget' souls.

What is a Fiscal Year?

Any twelve-month period that is used for submission of accounts, taxation purposes and to state financial reporting by private and public sector companies is called a Fiscal Year.

In India, the Government has laid down the provision that the 12–month starting on April 1 and ending on March 31 of next year will be treated as a Fiscal Year.

To put it in perspective, this article is being written on 31 January 2021, i.e., in Financial Year 2020–21 (FY21). This is also called Fiscal Year ’21.

In the same way, the financial year for 2021–22 will start on 1 April 2021 and will end on 31 March 2022. So on 1 April 2021, we will enter Fiscal Year ’22. 

What is the Economic Survey?

The Finance Minister's Budget Speech contains two major components: Part A and Part B.

Part A of the Speech contains the Economic Survey while Part B comprises the Union Budget Speech.

The Economic Survey is an assessment of the performance of the Indian economy in the financial year going by. For example, the Economic Survey 2020–21 presents an assessment of the performance of the Indian economy in that financial year (i.e., 2020–21). 

The Economic Survey 2020–21 was tabled on 29 January 2020. You can access it here.

What is the Budget?

The Union Budget is a statement of revenues and expenditures for the coming financial year, i.e., the one that starts on April 1 of this year.

Why is the Union Budget presented in February?

The Finance Minister of India presented the annual Union Budget for 2021–22 in the Parliament of India on February 1. It is typically presented in February (and not in March) for the following reasons: 

(a) After its presentation, the Budget is tabled in the Parliament so that MPs can, over the next few days, discuss and debate the various provisions listed in the Budget. 

(b) After the parliamentary debate, any amendment to the original provision (like increasing or decreasing the allocation for a said ministry/program and rolling back any budget proposal) will have to be tabled, discussed, passed, and brought into law by the Parliament. 

(c) Also, the administrative system, especially in case of tax administration, would need to be geared up to reflect any change in the financial, taxation or any other system.

I hope this is good! Please leave feedback in the comments section.

Can Iran risk a war against the U.S.?

In this short note, I will focus on two important questions on the fluid situation in West Asia following the killing of Qosem Soleimani, arguably the second most powerful person in Iran and the head of its Quds Force, a special branch of the Iranian Revolutionary Guard Corps (IRGC).

The global media is screaming from the roof-top about an impending World War III. Well, I have a contrarian viewpoint. Here it is.

Can Iran risk a full-fledged war?

No.

Iran cannot risk a full-scale war against the United States.

Its economy is tottering, especially in light of the economic sanctions imposed by the U.S.; here's a short note.

(a) Iran's GDP is likely to contract by 9.5 per cent, i.e., produce a tenth less than the previous year. 

(b) Sanctions, imposed by the U.S. for Iran’s pursuit of nuke weapons, have
dragged the budget revenue down, which has squeezed the money available for welfare schemes;

(c) oil production has fallen by nearly 90 per cent;

(d) exchange value of the currency (Rial) has dropped significantly (one American dollar gets you 1,40,000 rials at the current exchange value); and

(d) the country is rationing petrol at 60 litres per person at 15,000 rials per litre (anything above is sold at 30,000 rials).

It is true that Iran has developed a large arsenal of missiles and other weapons despite being under the burden of debilitating sanctions. Its missiles can reach Israel, an arch-foe. However, Iran may not enjoy a first-strike capability as Israel has the highly effective Iron Dome anti-missile interceptor.

Even if Iran does strike Israel with a missile first, it would have to bear the brunt of a sustained barrage of missile strikes from Israel.

Iran knows that it does not have the military capability to engage in direct confrontation with the U.S.; its conventional decades-old military machine is no match for the world’s most advanced weapons system of the U.S..

Also, almost all of the oil and gas plants of Iran are on its coast in the Gulf. In the event of a full-scale war, it is likely that the U.S. will seek to destroy these strategic assets, which are at the heart of the Iranian economy.

Once destroyed, there is precious little the Iranians can do fuel their war effort; no money will flow from the destroyed energy assets.

What is the most likely way for Iran to respond?

As Iran cannot risk a full-scale direct military confrontation against the U.S. and Israel, it will most likely resort to ‘asymmetric warfare’, an idea pioneered and built by Qosem Soleimani.

In the last two decades or so, Soleimani raised, nurtured, armed, funded and guided several Shia militia groups across Iraq, Syria, and Lebanon. The most popular of these militias is the Lebanon-based Hezbollah.

It is most likely that Iran will attack the U.S. and Israel using these militias as proxies to advance its interests. Considering that most of the militias are disparate groups, it may become greatly difficult for the Americans and the Israelis to defeat them.

In the fast-developing scenario enveloping West Asia, Iran might scream itself hoarse, but it knows that its best bet to hurt its biggest enemies is by using asymmetric warfare through its proxies.

Rising Unemployment in India

The latest data on unemployment in India points to a significant surge. In fact, at 7.5%, the latest unemployment rate is the highest in 38 months, reveals the CMIE data. For calculation of this rate, the base is October–December 2015.

So, what is unemployment rate? 

Unemployment rate is the ratio of the unemployed to the working age population that is willing to work. If therefore considers only a part of the working age population – the part that is willing to work. 

In other words, the ratio of the employed to the working age population is called the employment rate.

India has a total labour force of about 52 crore. A low labour participation rate means fewer people are willing to work. 

In January 2016, the labour participation rate was 47%; it is down to 43% in October 2019, which effectively means that fewer people in the labour force are looking for and participating in work. 

There is a problem here: even though the labour participation rate is down to 43% (i.e., fewer people are participating in work), even these fewer people are not finding jobs (unlike in 2016). 

To put in perspective, of the 43% of the working age population willing to work, 7.5% are unable to find any work.

In light of the global slowdown and the deceleration in the Indian economy, the employment situation is unlikely to improve in the near future.  

U.S.-China Trade War: A Lowdown

A short explainer on the trade war between the U.S. and China. 

U.S. trade in goods with China  

(latest info, as of November 2018, sourced from www.census.gov, a U.S. government website)

• Imports from China: U.S.$493.49 billion
• Exports to China: U.S.$111.16 billion
• Trade Balance: minus (–)U.S.$382 billion

Why

The U.S. accuses China of high tariffs (taxes) on American products, which make them expensive for the Chinese to buy.

Also, Washington has accused Beijing of doing nothing to prevent theft of intellectual property rights (like counterfeit goods and pirated software) and stealing of trade secrets (including through corporate espionage or by breaking into computer systems of American companies to gain access to cutting-edge technologies). The U.S. estimates the damages from China’s bad behaviour at around $600 billion.

Tariffs & Impact

To punish China for its bad behaviour and inaction, the U.S. imposed high tariffs on around Chinese goods (like handbags and heavy machinery) with $250 billion. Tariff increases ranged between 10% and 25%.

China hit back with $110 billion in tariffs on American goods.

The U.S. has postponed imposing another of tariffs on Chinese goods (worth $200 billion) as negotiations are underway to broker a better trade deal.

As of today, the Chinese have agreed to buy more American goods, especially agricultural products (like soybean). Farmers are among the major vote banks of Donald Trump. However, to push Trump to buckle down, China has imposed higher tariffs on goods (like coal and chemicals) made in Republican strongholds.

Beijing has also agreed to reduce tariffs on some American products to help those products gain wider market access.

Tariffs (taxes) on Chinese goods would make American products cheaper (comparatively) in the home market. This would induce Americans to buy more American goods (and not expensive Chinese goods).

China’s exports to the U.S. make for nearly 25% of its total exports. A drop in its exports to the U.S. could harm Beijing a lot more than it is willing to admit; of course, bragging aside, Beijing knows that a drop in exports to the U.S., especially amid a slowdown in its economic growth, could lead to industrial contraction, higher unemployment, and social unrest.

Status today

Both the U.S. and China have dug in their heels, though both countries cannot afford to do that for a long haul. Washington and Beijing are waiting for the other to blink, though both parties are staring at each other.

Venezuela Crisis in a Nutshell

In this short explainer on the crisis enveloping Venezuela, I have tried to be brief and to the point.

Nicolas Maduro                   Juan Guaido

Who’s Who in Venezuela

President: Nicolas Maduro, a hardcore socialist, anti-U.S., leader of United Socialist Party of Venezuela.   

Who supports Nicolas Maduro:

    (a) Within Venezuela: Supreme Court of Venezuela, Defence Forces of Venezuela, PDVSA (state-owned oil company); 

(b) Outside Venezuela: China, Russia, Turkey, Iran, Bolivia, Cuba, Nicaragua  (last three are in the Americas).

Who does Maduro blame for the current crisis: United States of America.

Challenger: Juan Guaido, self-declared Interim President since January 2019 and leader of Popular Will, a centrist party.

Who supports Juan Guaido:

(a) Within Venezuela: Low-ranking military officials and huge popular support.
(b) Outside Venezuela: U.S., UK, Argentina, Brazil, Chile, Colombia, Ecuador, Peru, Panama, Costa Rica, Guatemala, and Honduras.

Role of Oil in Venezuelan Economy

• Oil reserves in Venezuela are said to be among the top 3 in the world.
• Oil accounts for 98% of export earnings. 
• Oil accounts for 50% of GDP
• High global oil supply, falling crude prices, and poor extraction technology have led to a big decline in oil production – all of which have drastically reduced the government’s export earnings, thereby widening revenue deficit. 
•  In 2018, GDP shrunk by double digits for the third consecutive year. 
• Government does not have foreign exchange reserves to pay for imports and loans. 
  
• Venezuela has been in default since 2017 – meaning, it has not paid back foreign loans and not paid for imports. 
  
• U.S. and other countries have a long-running embargo against Venezuela; this has shrunk market for Venezuelan products and reduced avenues for borrowings.
  

Major Problems

• Great political and economic instability 
• Mostly, a result of catastrophic humanitarian emergency. 
• Severe shortage of food, medicine, & other essentials – mostly because of hoarding, embargo, and hyperinflation. 
• Hyperinflation, meaning very, very high rate of inflation, is leading to doubling of prices of essential goods every 19 days on average. Current inflation is around 85,000%. Thousands of health professionals have left the country, leading to medical emergency. 
• Lack of access to food and healthcare have pushed 90% of people below the poverty line.  
• On average, a Venezuelan has lost around 12 kg of body weight since 2017. 
• It is believed that some 3 million have already fled Venezuela; the number is likely to rise to 5 million by the end of 2019.
  

In a nutshell, years of economic mismanagement, misdirected welfare policies (subsidizing almost everything through high revenue earned by oil exports), huge debt, massive shortage of essential stuff, hyperinflation, political instability – have all led to the current catastrophic humanitarian crisis in Venezuela.

The Explainer: Budget at a Glance

In India, there is hardly any economic event that captures popular imagination as much as the Union Budget. This Explainer will focus on the complex budget jargon that puts off even 'interested–in–budget' souls.

What is a Vote on Account?

The Central Government must seek approval of the Parliament to withdraw money from the Consolidated Fund of India to meet expenses.

A full budget goes through a long process; with elections due soon and without parliamentary approval, the Central Government may run out of cash to meet expenses. This may paralyze the functioning of the government (a la the shutdown in the U.S.).

Tell me more about Vote on Account (VoA).

VoA is generally undertaken for only two months and can’t exceed six months.

VoA is taken in two cases:

o   Government is unable to pass a full Budget by 31 March;

o   Term of the current government ends close to 31 March.

VoA is different from Interim Budget in one major aspect:

o   Interim Budget focuses on both revenue & expenditure whereas the VoA focuses ONLY on expenses.

What is a Fiscal Year?

Any twelve–month period that is used for submission of accounts, taxation purposes and to state financial reporting by private and public sector companies is called a Fiscal Year.

In India, the Government has laid down the provision that the 12–month starting on April 1 and ending on March 31 of next year will be treated as a Fiscal Year.

To put it in perspective, this article is being written on 1 February 2019, i.e., in Financial Year 2018–19. This is also called Fiscal Year ’19.

In the same way, the financial year for 2019–20 will start on 1 April 2019 and will end on 31 March 2020. So, on 1 April 2019, we will enter Fiscal Year ’20.

Define Budget.

The Budget is a statement of revenues and expenditures for the coming fiscal year, i.e., the one that starts on April 1 of this year.

What does the Budget consist of?

Look at the table graphic below. This document titled, Budget at a Glance, is the best document to understand the components of the various types of figures in the Budget.

The Union Budget 2019–20 consists of the following:

(a)   Actuals for 2017–18,

(b)   Budget Estimates for 2018–19,

(c)   Revised Estimates for 2018–19, and

(d)   Budget Estimates for 2019–20.

The Actuals for 2017–18 may be represented as such but they STILL would be PROVISIONAL only. This means that these figures are NOT the final figures for 2017–18 but are subject to further revision. In fact, the final figures for 2017–18 will only be available toward the end of Financial Year 2018–19 (or Fiscal Year ’19).

Budget Estimates (BE) relate to the figures set out by the Finance Minister in his Budget Speech last year (i.e., in February 2018) for the Financial Year 2018–19.

However, all figures – related to revenue collection, expenditure, other allocations – are subject to change. These numbers are mere ESTIMATES and not actuals. As the year progresses, such figures may sometimes need to be revised. For example, if there is low industrial and agricultural activity (meaning lower economic output), tax collections may dip. 

This, in turn, will reduce the government’s Revenue Receipts.

In such case, the Government may revise the Budget Estimates (made in the Budget). Such altered figures are labeled Revised Estimates (RE). These RE are listed in the third column.

In the fourth and last column, you will find Budget Estimates for the coming Financial Year 2019–20. These figures reflect the various estimates made by the Government in terms of Receipts (including tax collections) and Expenditures (including interest payments and salary payments to government employees).

Datagraphic: India's Top 5 Export & Import Partners

Datagraphic: Top 5 Highest Per Capita GDP

Datagraphic: Top 7 Economies by GDP (Nominal)

India was ranked the sixth biggest economy by GDP in 2017; however, it is back to being the seventh  biggest economy. 

Weekend Videos

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The Explainer: India's External Debt

India’s external debt, as at end December 2017, was at around U.S.$513.4 billion. 

Over the years, several people have asked me a pertinent question: Is this the money the Government of India owes to external agencies like the World Bank (WB) and the International Monetary Fund (IMF)? 

Well, the answer is complicated.

To understand external debt, let’s use the traditional Q&A method. 

Give me a breakdown of India’s external debt.

India’s external debt is a mix of both long-term and short-term debt.

(a) There is a dominance of long-term borrowings – 81 per cent (U.S.$415.8 billion) of the total debt of U.S.$513.4 billion. 

(b) The remaining 19 per cent (U.S.$97.6 billion) is short-term external debt. This means this debt would come up for payment in the next twelve months. 

Define debt by types of maturities.

The maturity of a loan relates to its repayment period, i.e., when it becomes due for repayment.

Based on maturity, there are two kinds of loans: long-term and short-term. 

A long-term loan is a loan with a maturity period of more than one year. The longer the maturity period of the debt the lower the pressure on payments.

A short-term debt has a maturity period of less than one year, i.e., this debt would come up for repayment in the next twelve months. This debt, in the case of external debt, includes both the principal as well as interest on such loans. In other words, short term external debt includes short term debt by original maturity as well as long term debt.

What are the components of External Debt?

There are several components of India’s external debt. However, for the common person to understand something as complex as external debt, the following are the main components of India’s external debt:

• Multilateral credit – borrowed by the Government of India from institutions like the International Monetary Fund and the World Bank;

• Bilateral credit – borrowed by the Government of India from other countries (like Japan and Germany);

• External commercial borrowings (ECBs) – these are the borrowings of companies like Reliance Industries from abroad;

• Deposits of Non-Resident Indians (NRIs). NRI deposits are treated as liabilities as they have to be repaid to the depositors, and

• Foreign Institutional Investment (FII) – investment by foreign fund houses (like mutual funds) in India’s stock markets and government securities.

As mentioned, India’s external debt is U.S.$513.4 billion. So, does it mean the Government of India borrowed all this money?

Yes, but just a part of it. Government debt is also called ‘Sovereign’ debt. 

The share of the Government’s debt in the total external debt is just 21.2 per cent (U.S.$108.9 billion). The remaining 78.8 per cent is non-Government debt (U.S.$404.5 billion). 

What are the components of Government debt?

Of the total Government debt of U.S.$108.9 billion,

• 42.1 per cent has come from multilateral agencies (like the World Bank and the International Monetary Fund);

• 18 per cent came from bilateral creditors (like Japan). In fact, Japan was the single biggest lender to India – nearly 79.7 per cent of bilateral credit came from Tokyo, followed by Germany at 10.9 per cent and Russia (5.3 per cent), and

• 39.9 per cent was sourced from Other Sources (like foreign institutional investment in government securities and defence debt).

How does India compare with the rest of the world in external debt?

India compares quite favourably with the rest of the world in external debt. 

India’s external debt to GDP ratio is 20.4 per cent – among the lowest in the developed and developing world. For the U.S., it is nearly 100 per cent while it is 14 per cent for China.

India’s foreign exchange reserves to total external debt is also good – 74.8 per cent (based on World Bank data for 2016). 

India is not vulnerable to any major or minor problem arising on the external debt front. 

Please share your feedback in the comments section.

The Explainer: Korean Economic Models

Under the influence of the Soviet Union, North Korea became a Communist State under Kim Il-sung. The Soviet Union propped up the Kim regime with military and economic aid. On the economic front, Pyongyang adopted a socialist economic model, where everything was owned by the state; however, as the country was controlled by the Kim family, its economy became a Kim family enterprise.

On the other hand, South Korea, under the U.S., took the democratic path to governance. Democracy and its attendant institutions, like a free press and an independent judiciary, took shape in South Korea. A free market economy took root in the democratic South – freedom of economic activity, private enterprise and a culture of consumerism became a way of economic life. The South is one of the most technologically advanced nations in the world. Some of its private enterprises like Samsung, LG, and Hyundai are global mega brands. 

A Comparison of the Two Koreas – Basic Data

Parameter North Korea South Korea Area (in km2) 1,20,540 100,210 Population (in million) 25.3 51.4 GDP (in U.S.$ billion) 25 1498 Per Capita (in U.S.$) 1,000 29,114

Data source: Wikipedia