What is fiscal deficit ?
Fiscal deficit is the difference between Government’s total expenditure and non-debt capital reciepts. Revenue receipts, recoveries of loans and other receipts are all non-debt capital recipts. We subtract these from Total expenditure incurred by government to find out Fiscal deficit.
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 to fund the allocations and expenditures listed in the Union Budget.
What are the adverse consequences of high Fiscal deficit ?
A high fiscal deficit is bad for state of the economy, trade balance and currency exchange rate.
Rising Interest rates– A high fiscal deficit would mean the government’s borrowings are high. When the government borrows moeny from the general public, it creates demand for money. Lending to government carries zero risk, as the government does not default on repayment. However, greater government borrowing would mean less money would be available for lending to industrial and other sectors of the economy. This would push up the interest rates for the borrowers of the industry.
Reduced business and economic activity- Higher interest rates would add to overall, cost of production, thereby increasing cost of operations. This in turn would render business activity like increased production and expanding operations, unviable. Hence, a lot of businesspersons would then opt out of such economic activity as they no longer find it profitable.
Reduced income and employment generation- If due to higher interest rates businesspersons opt out of economic activity or close down plants, it would also lead to fall in employment. This would in turn mean that the unemployed don’t earn income and hence it would reduce their purchasing power. This implies fall in aggregate demand for goods and services. This would reduce investment and industrial activity, thereby depressing the overall economic scenario.
Lowers exchange rate and increases trade deficit- Sometimes, government of India would borrow from foreign sources. When the government borrows foreign exchanges comes into the economy. This would increase the supply of foreign currency, which can in turn be exchanged for domestic currency. The rise in demand for Domestic currency would increase its value. The value of Indian rupee will increase. If exports go down and imports rise the trade deficit will also widen which in turn increases the current account deficit. High borrowing and increase in current account deficit would mean country’s financial position becomes precarious as it piles higher debt and greater interest burden on future generation.
In short, a higher fiscal deficit is dangerous in every way possible for economic activities, trade balance, exchange rate and employment act.