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Fiscal Deficit: What is it & Why it should be in the Range

Introduction

When you make a budget, you create a plan to spend your money for a future period. This plan lets you know if you have enough money for all your expenses. You aren’t the only one who makes use of this helpful tool. Just like you do, even governments plan out their budgets. They plan the amount of income and expenses for the next financial year.

But despite the budget, what happens if the government’s expenditure for the financial year is more than their income? This shortfall in the government’s income compared to spending is a fiscal deficit. Let us now understand in detail about fiscal deficit.

The financial year in India is between 1st April to 31st March every year. The government prepares its budget for this period. After preparing it, they present this budget every year on 1st February. That is to ensure that new spending plans and tax proposals can be approved before the financial year starts in April.

When they present the budget in February, the government also talks about its fiscal policy. This policy lets the government decide on many factors like how much to tax, where to spend, how much money needs to be spent on growth, etc. When the government receives more money than it spends, it has a surplus of funds. When it receives less, it has a deficit.

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The fiscal deficit is one of the key points in the budget that everyone takes notice of.It is the difference between the government’s total expenditure and total income received in a year. Fiscal deficit can be represented by the below formula:

Fiscal deficit = government’s total expenditure (capital and revenue expenditure)- total income received by the government (revenue receipt+ recovery of loans + other receipts)

The government compares the actual fiscal deficit for the previous year with the estimated figures. They also mention an estimate of the fiscal deficit for the following year. They try to maintain this deficit in control without much deviation. They peg the fiscal deficit as a percentage of its gross domestic product (GDP). India’s GDP is the total value of all the finished goods and services it produces. A fiscal deficit can also be an absolute amount of actual rupees spent over income.

One of the ways how the government meets its fiscal deficit is to borrow. They can do so is by issuing bonds and other short-term debt instruments like treasury bills.

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Why is it essential for fiscal deficit to be in range?

 When the fiscal deficit strays away from the range or is on the higher side, the government needs to increase their borrowing and it can cause an increase in interest rates. High interest rates will increase the cost of production, and higher prices will be passed on to the consumers and this will lead to an inflation.

Non-productive expenditure has a higher impact on inflation as productive expenditure boosts both demand and supply.

Many times governments spend a higher amount to boost the economy. The Covid-19 pandemic has created a lot of stress for the country’s fiscal position. There was a shortfall in revenue and a sharp decline in GDP. Due to this, the government has made plans to introduce a range-bound fiscal deficit target to strengthen the economy. This led to a higher fiscal deficit of 9.3% for FY 2021 against the earlier budgeted deficit of 3.5% of the GDP.   A higher fiscal deficit can also lead to a fall in the sovereign rating, which could impact the country's capital flow

Additional Read: How to beat inflation with your portfolio

Conclusion

All developing economies generally have a fiscal deficit and a high deficit is not necessarily bad. If the country is spending on development and growth, it might increase the government’s income after some time. The impact on inflation depends on what the expenditure is used for. A fiscal deficit due to a productive investment can reduce the impact of inflation and can give a good result in the long term.

Disclaimer – ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.

 

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