Finance Ministry is trying hard these days to curtail the Fiscal Deficit somehow which is currently as high as 5.3% of the GDP. What is this fiscal deficit? What is this buzz all about? Fiscal deficit takes place when a government’s total expenditures exceed the revenue that it generates (excluding money from borrowings). In simple terms, it is the difference between the ever increasing expenditure and small income.One can not think of utopian economic situation in a developing country like India and to have zero fiscal deficit as it will slow down the economic growth of the nation.
Too much of economics? Let’s try to analyze things in a simpler way. Suppose you have 30,000 bucks as your monthly income and your total expenditure for a certain month is 35,000. Now you need to raise the additional money required somehow and luckily you have a very generous friend of yours who is ready to lend you the difference. So, in such a case 5,000 will be your fiscal deficit. Doesn’t seem to be much of a problem right? The real lies problem lies with how you are going to spend that 5,000. It won’t be much of a problem if you want to buy a camera or invest the money once only but it can create a huge trouble if the expenditure is recurring one let’s say treating your girlfriend.
The next month, supposing your income remains flat and you are not able to meet your ends once again, you again approach one friend or the other and someone comes up to the rescue and provides you money without asking for the principal amount immediately and just demands the interest. You were already in need of more money and adding to your worries are now the interest liabilities. The problems get compounded. You now start curtailing on the capital part and your new loans are just for running the system. A scenario is reached when the interest payment by you requires loans from him. And this is the situation when your are doomed and things have got really messed up.
This is exactly the current situation of India. For benefit of the people and sometimes just to fulfil the political motives, government has been giving subsidies on oil even to the rich people driving SUVs more than it can sustain and to add to the problem are various bills passed just with the motive of staying in power. As a result we have a huge fiscal deficit piling up in front of us and we don’t have enough money to run the existing system. Hence, government keeps on borrowing money to pay the interests only. Unlike an individual who may or may not get loan from his friend, there are many agencies who are bound to lend money to the government, be it RBI or any other bank.
Suppose you are in a similar kind of situation. All you wish for is you had a ‘money tree’ or a currency printing machine with you. The government is one step ahead of you as it has control over the currency flow in the country, though indirectly. Consider this, if the government prints currency rampantly but the production is constant, it will lead to increased inflation as more money in the economy chases the same amount of goods. Curtailing the fiscal deficit by printing money can have damaging effects and can burst the whole economy. A classic example in this context is of Zimbabwe which had inflation rate of 300,000% at one time.
After the enactment of liberalization policy, billions of liabilities were being added every year. A major part of the revenue collection through tax went alone to interest payments. In the light of need of change, government introduced the Fiscal Responsibility and Budget Management Act (FRBMA) in 2003. The main purpose was to eliminate revenue deficit of the country and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008 by reducing it at a minimum rate of 0.3% annually. The Act provided that the government shall not borrow from the RBI except under exceptional circumstances where there is temporary shortage of cash in particular financial year.
However, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the act was initially postponed and subsequently suspended in 2009. In 2011, given the process of ongoing recovery, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA. With the upcoming elections in 2014, one can not believe that current government will take any harsh steps for the enactment of FRBMA and curtailing the fiscal deficit as it involves short term pain and the government doesn’t want to take risk. Considering the ongoing scenario, it’s hard to predict whether FRBMA will actually come into existence or not and how will India be able to manage its Credit Rating.