Deficits & Deficit Financing

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Deficit is difference between the Expenditure and Receipts
Person A, Income 9000, Lone of Credit 12000 for 12 Month (1000/month). So total receipts are 10000 rupees.
1st Month – Expenditure is 12,000 (9000 +1000+2000[Borrowing])
2nd Month – Expenditure is 11,100 (9000 +1000+1100[Borrowing]).
For 2-month Total Expenditure-23,100, Total Receipts-20,000 [18,000 (Income) & 2,000 (Line of Credit)] & Borrowing- 3,100.
1. Budget Deficit
  • Budget deficit is difference of total expenditure and total receipts Budget Deficit = (Total Expenditure – Total Receipts) = (Capital Expenditure + Revenue Expenditure) – (Capital Receipts + Revenue Receipts)
=23,100 – 20,000 = 3100
2. Revenue Deficit
Revenue deficit = Total Revenue expenditure – Total Revenue receipts
  • Revenue deficit is excess of total revenue expenditure of the government over its total revenue receipts.
  • It is related to only revenue expenditure and revenue receipts of the government.
  • Revenue deficit actually indicates that the government’s own earning is inadequate to meet normal functioning of government departments and provision of services.
  • Revenue deficit results in borrowing.
  • When the government spends more than what it collects by way of revenue, it incurs revenue deficit. The revenue deficit includes only such transactions which affect the current income and expenditure of the government.
  • Revenue deficit in government budget reflects government’s inability to meet its revenue expenditure fully from its revenue receipts.
  • The deficit has to be met from capital receipts, i.e., through borrowing and sale of its assets. Like the case of current disinvestments done by government.
  • Effective Revenue Deficit
    • Effective revenue deficit (ERD) is a new term introduced in the Union Budget 2011–12.
    • Conventionally, ‘revenue deficit’ (RD) is the difference between revenue receipts and revenue expenditures. Here, revenue expenditures includes all the grants which the Union Government gives to the state governments and the UTs— some of which create assets (though these assets are not owned by the Government of India but the concerned state governments and the UTs).
    • According to the Finance Ministry (Union Budget 2011–12), such revenue expenditures contribute to the growth in the economy and therefore, should not be treated as unproductive in nature like other items in the revenue expenditures.
    • And on this logic, a new methodology was introduced to capture the ‘effective revenue deficit’, which is the Revenue Deficit ‘excluding’ those revenue
    • Expenditures of the Government of India which were done in the form of GoCA (grants for creation of capital assets).
    • Effective Revenue Deficit = Revenue deficit – Grants for creation of Capital Assets (GoCA)
3. Fiscal Deficit
(Line of Credit – 12000 for 12 Months – Give 1000 rupees each month.
Ex: Fiscal deficit = Total Borrowing,
Calculated,
  • Fiscal deficit is total borrowing, 1000 per month (line of credit) is also borrow amount. So add all borrowing,
    • = 5,100 (2x1,000[line of credit] +2,000+1,100).
  • Fiscal Deficit = TE – Total Receipts exclude Borrowing (Non debt creating Receipt)
    • =23,100-18000 = 5,100.
  • Fiscal deficit = Budget deficit + Borrowing (in Capital Receipts [line of credit])
    • = (23,100 – 20,000) + 2,000 = 5100.
  • A situation of fiscal deficit is said to happen when the government’s total expenditures exceed the revenue that it generates excluding the money from borrowings. The deficit is different from debt. Debt is actually an accumulation of yearly deficits.
  • The fiscal deficit is defined as an excess of total budget expenditure over total budget receipts excluding borrowings during a fiscal year. It is the amount of borrowing the government has to resort to meet its expenses.
  • A large deficit means a large amount of borrowing. The fiscal deficit is a measure of how much the government needs to borrow from the market to meet its expenditure when its resources are inadequate.
  • Fiscal deficit = Total expenditure – Total receipts excluding borrowings
The fiscal deficit is, in fact, equal to total borrowings. Thus, the fiscal deficit is an indicator of the borrowing requirement of the government.
Fiscal Deficit reflects the health of the economy; A large FD indicates the economy is under stress.
A large Fiscal Deficit
  • can create inflation in the economy.
  • makes the country unattractive to foreigners.
  • can lead to outflow of capital from the country.
  • crowd out/reduces private investment from the economy.
If a large part of FD is due to revenue deficit, it implies the government is borrowing to finance its consumption requirement. This is a dangerous situation, and soon the government will go bankrupt.
4. Primary Deficit
  • Primary deficit is defined as a fiscal deficit of current year minus interest payments on previous borrowings.
  • Fiscal deficit indicates borrowing requirement inclusive of interest payment. However, primary deficit indicates borrowing requirement exclusive of interest payment (i.e., amount of loan).
  • It shows how much government borrowing is going to meet expenses other than interest payments. Thus, zero primary deficits mean that the government has to resort to borrowing only to make interest payments.
  • To know the amount of borrowing on account of current expenditure over revenue, we need to calculate the primary deficit. Thus, the primary deficit is equal to fiscal deficit fewer interest payments.
Primary deficit = Fiscal deficit – Interest payments
=5100 – 100 = 5000.
Primary Deficit = Total Expenditure – (Total Receipts exclude Borrowing) – Interest Payment.
= (23,100 – 18,000) – 100 = 5000.
5. Monetised Deficit
(Printing New money for deficit financing)
  • The part of the fiscal deficit which was provided by the RBI to the government in a particular year is Monetised Deficit, this is a new term adopted since 1997–98 in India.
  • This is shown in both the forms—in quantitative as well as a percentage of the GDP for that particular financial year.
  • It is an innovation in the fiscal management which brings in more transparency in the government’s expenditure behavior and also in its capabilities concerning its dependence on market borrowings by the RBI.
Deficit Financing
  • The act/process of financing/supporting a deficit budget by a government is deficit financing.
  • In this process, the government knows well in advance that its total expenditures are going to turn out to be more than its total receipts and enacts/follows such financial policies so that it can sustain the burden of the deficits proposed by it.
These means are given below in order of their suggested and tried preferences.
1. External Aids
  • External Aids are the best money as a means to fulfil a government’s deficit requirements even if it is coming with Soft interest & Hard Loan. If they are coming without interest nothing could be better.
    • External Grants are even better elements in this case (which comes free—neither interest nor any repayments)
    • External Borrowings are the next best way to manage fiscal deficit with the condition that the external loans are comparatively cheaper and long-term.
Though external loans are considered an erosion in the nation’s sovereign decision making process, this has its own benefit and is considered better than the internal borrowings due to two reasons:
  • External borrowing brings in foreign currency/hard currency which gives extra edge to the government spending as by this the government may fulfil its developmental requirements inside the country as well as from outside the country.
  • It is preferred over the internal borrowings due to ‘Crowding out effect’. If the government itself goes on borrowing from the banks of the country, from where will others borrow for investment purposes? Lower Investments by the local borrowers will discourage investment rates and leads to slowdown in GDP growth.
2. Internal Borrowings
  • Internal Borrowings (G-Sec, Bank, Public Account – Limited loan) come as the third preferred route of fiscal deficit management. But going for it in a huge way hampers the investment prospects of the public and the corporate sector.
3. RBI
  • RBI is the last resort for the government in managing its deficit. But it has the biggest handicap that with it the government cannot go for the expenditures which are to be made in the foreign currency, it leads to high inflation and It brings in regular pressure and obligation on the government for upward revision in wages and salaries of government employees.
    • Ways Means Advance (WMA) – For Both Union & State.
      • Special - Govt borrow short term (90 days) loan by pledging G-Sec interest less than Repo Rate.
      • Normal - Govt borrow short term (90 days) loan, interest at Repo Rate.
      • (Special & Normal Borrowing Value fixed by RBI).
    • Monetisation (Printing New Currency).
Good Characteristic of Budget
  • Capital Expenditure – Assert making process.
  • Low Revenue Deficit.
  • Fiscal deficit under Control.
  • Tax Receipts should be high (Non burdening to common public).
  • Internal borrowing – Crowing out effect should have kept in mind.
  • Deficit Budget on Capital side.

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