Gross Fiscal Deficit of India - Implications & Fiscal Policy Framework | UPSC Economy Notes

Gross Fiscal Deficit is the surplus of the government’s total expenditure, current, and capital, as well as loans net of recovery, over revenue receipts, including foreign grants and non-debt capital receipts. The gross fiscal deficit (GFD) is the excess of total expenditure, including loans net of recovery over revenue receipts (external grants) and non-debt capital receipts. Since 1999-2000, GFD excludes States’ share in small savings as per the new accounting system.

In this article, we will cover entire India’s Gross Fiscal Deficit exceeding the Target, Recent updates on Fiscal Deficit, Types of Deficit, What fiscal deficit is, the Formula for Fiscal Deficit, Trends of Fiscal Deficit in India, Fiscal policy framework of India, fiscal Consolidation in India and some of the key highlights. Gross fiscal deficit is one of the important topics of the UPSC IAS exam.

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Recent update on Gross Fiscal deficit

• As of September 2022, the central government's fiscal deficit for April through August FY23 was Rs 5.4 trillion, or 32.6% of the Budget Estimate BE of Rs 16.6 trillion.
• Comparatively, the fiscal deficit for the same period last year was Rs. 4.68 trillion, or 31.1% of the target for FY23.
• The Center expects its fiscal deficit to be 6.4% of the year's nominal GDP.
• The amount collected in net tax for the April to August FY23 period amounted to Rs 7 trillion, up 8.5% from the amount collected during the same time last year.
• For the first five months of FY23, non-tax revenue was Rs 1.17 trillion, 21% less than April through August of FY22, while non-debt capital receipt was Rs 31,527 crore, more than twice as much as the previous year.
• Following recent steps, such as introducing a windfall tax on petroleum exports and increasing the import fee on gold, the administration is confident of fulfilling its budget deficit objective.
• For 2022-23, the government's fiscal deficit is estimated to be ₹16,61,196 crore.
• It anticipates the revenue gain from these measures to more than cover the higher spending on subsidies and the revenue loss from excise tax decreases.
  • There were fears that the Centre would miss its budget deficit target due to excessive subsidy payments.
• The gross borrowing of the Centre for fiscal 2023 is estimated to be 14.95 lakh crore.
• Another official stated that the administration was committed to the fiscal deficit target of 6.4 per cent of Gross Domestic Product (GDP) for the current fiscal year.
• The government allocated 2.07 lakh crore for food subsidies in FY23, less than the revised 2.86 lakh crore for FY22.
• However, extending the Pradhan Mantri Garib Kalyan Anna Yojana from six months to September is projected to increase the subsidy bill to approximately 2.87 lakh crore.
• According to official figures, the budget deficit for April-May, the first two months of FY23, was 2.03 lakh crore, or 12.3 per cent of the target for the entire fiscal year, owing primarily to greater expenditure.
• According to the Reserve Bank of India, India’s foreign exchange reserves climbed by $2.734 billion to $593.323 billion in the week ending June 24.
• The administration is taking steps to deal with the international market’s soaring crude oil costs. India imports 84 percent of its petroleum needs (2020-21), and a weakened currency has made imports more expensive.

Check out what is FDI in retail here.

What Is Gross Fiscal Deficit?

Gross Fiscal Deficit (GFD) is the excess of total expenditure, including loans net of recovery over net of revenue and non-debt capital receipts. A fiscal Deficit is defined as the total revenue and expenditure of the government in a financial year. The net fiscal deficit is the gross fiscal deficit less the Central Government’s net lending.

In general, fiscal deficits result from either a revenue deficiency or a significant increase in capital spending. Capital investment is incurred to generate long-term assets such as factories, buildings, and other construction.

Government Revenue Sources	Government Expenses
Income tax Sales and provincial/state taxes Corporate taxes Duties and customs payments Investment profits and grants	Healthcare and medical research Defense Education Infrastructure

A deficit is often covered by borrowing from the country’s central bank or raising funds from capital markets through the issuance of various instruments such as treasury bills and bonds.

Also, check out the Price Deficiency Payment System (PDPS) here.

What is a Fiscal Deficit?

Fiscal deficit is calculated as total government spending less all revenue (including grants) less all other non-debt capital receipts. The difference between the government's outlay amount and its total non-debt capital receipts is known as the fiscal deficit. It displays the entire amount the government must borrow

Types Of Deficit

• Revenue Deficit is defined as the excess of the government’s total revenue expenditure over total revenue receipts. It arises when the real net income exceeds the projected net income.

Revenue Deficit = Total Revenue Expenditure – Total Revenue Receipts.

• Fiscal Deficit – Fiscal Deficit is the excess of total expenditure over total receipts for a fiscal year, excluding borrowings.

Fiscal Deficit = Total budget expenditure – total budget receipts(excluding borrowings)

• The fiscal deficit denotes the additional financial resources required to meet government expenditures.
• It indicates the government’s future responsibilities for interest payments and loan repayment. The government must repay the borrowed funds with interest in the future. As a result, the government must either borrow more from the people or tax them more to pay the interest and loan amount.
• Primary Deficit – It is defined as the fiscal deficit minus interest payments on earlier borrowings. The primary deficit reflects the government’s borrowing needs to fulfill expenditures, excluding interest payments.

Primary Deficit = Fiscal Deficit – Interest payments

• Net Primary Deficit equals fiscal deficit plus interest earned minus less interest paid. It displays the total amount of borrowing required by the central government.

Net Primary deficit = Fiscal deficit + Interest received – Interest payments

Study Measurement of National Income here.

Gross fiscal deficit of GDP India FY 2015-2020

The gross fiscal deficit for India’s fiscal year 2020 was predicted to reach a little over three percent of the country’s GDP. There was a decrease compared to the budget estimate for the nation’s deficit the previous year.

The Economic Slowdown

Despite optimistic market circumstances at the start of the year, GDP growth slowed in the June-September quarter of 2018. It decreased tax revenue collections for the government, which put more pressure on spending. India experienced its largest primary revenue shortfall (813932) in recent memory in 2017. However, the revenue shortfall as a percentage of GDP over the recorded period showed a progressive decline.

The Impact Of the Pandemic

At the beginning of 2019, the government raised its fiscal spending due to worries over steadily declining economic growth. The unprecedented financial stimulus package contributed to the deterioration of the gross fiscal deficit, the emergence of the coronavirus (COVID-19), and the ensuing lockdown. This put even more strain on the nation’s taxation system. The pandemic’s projected negative quarterly GDP growth in June 2020 for all of India was a significant effect. As of May 2020, the fiscal deficit was projected to be around two trillion Indian rupees.

Revenue Deficit at the End of 2021-22 

A revenue deficit is a difference between revenue receipts and revenue expenditures. Such a deficit suggests that the government will have to borrow money to cover expenses that might not generate income in the future. For 2021–2022, the expected revenue deficit is 5.1% of GDP. In contrast to the budget estimate of 2.7%, the revenue deficit for 2020–21 was greater at 7.5%.

Components Of The Fiscal Deficit Calculation

The Fiscal Deficit is calculated using two components – Income and Expenditure.

Income component

• The income component comprises two variables: revenue earned from different taxes and income generated from non-tax factors.
• The amount generated through corporate tax, income tax, customs duties, excise duties, and GST, among other things, constitutes taxable income.
• Meanwhile, non-taxable revenue is derived through external donations, interest receipts, dividends, profits, and receipts from Union Territories, among other sources.

Expenditure component

• The government provides cash in its Budget for various works, including salary payments, pensions, compensations, asset creation, infrastructure, development, health, and other areas comprising the expenditure component.

Also, check out the article on Strategic Debt Restructuring here.

Formula For Fiscal Deficit

Fiscal Deficit = Total expenditure – Total receipts excluding borrowings Or Fiscal Deficit = Revenue expenditure + Capital expenditure – Revenue receipts – Capital Receipts excluding borrowings

Trend Of Fiscal Deficit In India As a Percent Of GDP

The estimated fiscal deficit for 2022–23 is 6.4% of GDP, which is consistent with the broad fiscal consolidation strategy. Smt. Nirmala Sitharaman, Union Minister for Finance and Corporate Affairs, announced last year to achieve a fiscal deficit level below 4.5% by 2025–26. Furthermore, compared to the 6.8 percent forecast in the budget estimates, the revised fiscal deficit for the current year is estimated to be 6.9% of GDP.

Fiscal Policy Framework Of India

Here are some interesting facts about India’s fiscal policy

• The Indian Constitution mandates forming a Finance Commission (FC) every five years.
  • This is to provide the foundation for allocating some of the centre’s earnings to state governments and to provide medium-term fiscal guidance, as the states’ taxing capability is not always commensurate with their spending duties.
• The Budget, where the government accounts for its planned taxing and spending provisions for parliamentary debate and approval, is also an important aspect of fiscal policy.
• The five-year plans were an essential component of the fiscal policy agenda and are closely monitored by the Planning Commission to achieve the country’s long-term economic goals.
• Income tax, wealth tax, and other direct taxes are governed by the Income Tax Act of 1961, whereas indirect taxes such as sales tax and excise duty are governed by the proposed Goods and Services Tax (GST).
• The Fiscal Responsibility and Budget Management Act of 2003 (FRBMA) is a law about fiscal responsibility.

Study what is the Debt to GDP ratio here.

Fiscal Consolidation In India

• In 1994, Manmohan Singh, the finance minister at that time, planted the seeds for fiscal consolidation. 
  • He emphasised the need for fiscal discipline and announced a strategy to stop monetising the deficit in his budget speech for FY1995. 
  • Until then, the government had issued ad hoc treasury notes to generate new currency and finance its deficit. 
  • This made it harder for the Reserve Bank to implement efficient monetary policy. Manmohan Singh emphasised phasing out ad hoc treasury bills, after which the government would borrow money from the market to cover its deficit.
• In his budget address for FY01, Yashwant Sinha asked for a strong institutional structure to maintain fiscal discipline as open market borrowings accumulated to cover the deficit. 
  • As a result, the “Fiscal Responsibility and Budget Management (FRBM) Act, 2003” was passed, which imposed a cap on the fiscal deficit at 3% of GDP.
• The strategies for reducing the budget deficit are referred to as fiscal consolidation. To close a deficit, a government often borrows money. The company must set aside some of its profits to pay the debt. The interest burden will increase as the debt increases.
• To reduce the accumulation of debt and the deficit, the government has undertaken various policies at the national and sub-national levels. This is called fiscal consolidation. In its report, the Fifteenth Finance Commission (15th FC) has made the following recommendations:
  • By 2025-26, the central government should reduce its fiscal deficit to 4% of its Gross product.
  • By 2021-22, state governments should reduce their fiscal deficit to 4% of their Gross State Domestic Product and reduce it further to 3.5% in the next year and 3% for the next 3 years.

Read important Government Schemes here.

Concern With The Fiscal Deficit

A fiscal deficit signifies that the government’s debt load has increased. This has the following consequences:

• Credit Rating – This impacts sovereign creditworthiness ratings provided by global rating organizations, which tend to raise the government’s borrowing costs.
• Repayment issues in unexpected circumstances – Borrowing extra money implies you will have to repay it at some point. According to the 15th Finance Commission, COVID has already created significant budgetary uncertainty. Unforeseen future events, such as another epidemic or war, could lead to slower growth, and this debt will become a concern.

Check out what is Green GDP here.

Implications Of Fiscal Deficit

Implications of Fiscal deficit are as follows:

Spiral of Inflation

An inflationary spiral occurs when the general price level rises over an extended period, i.e., borrowing from the RBI, which increases the money supply and hence increases prices over time.

The National Debt

The national debt is born from a fiscal deficit. It stifles GDP growth since a disproportionate part of national revenue is spent on debt repayment.

The Dangerous Cycle of High Fiscal Deficits and Low GDP Growth

When the fiscal deficit is consistently high, it creates a situation in which GDP growth remains low due to the high fiscal deficit, and the fiscal deficit remains high due to the low GDP growth.

The Debt Trap

Borrowing causes two major issues: loan repayment and interest payment because interest payment still raises the revenue deficit. Further borrowing will be required to finance interest payments, resulting in a debt trap.

The Crowding Out Effect

A fiscal deficit causes the Crowding Out Effect. It refers to a situation in which significant government borrowings due to a large fiscal imbalance reduce the availability of capital for private investment. This diminishes overall economic investment.

Government Credibility is Degrading

A large budget deficit erodes the government’s credibility in domestic and international markets. This weakens the government’s credit rating, and foreign investors withdraw funds invested in the domestic economy. As a result, GDP decreased.

Also, check out the Balance of payment here.

HSBC Global Research Analysis of Budget Documents of States

• Estimates that, instead of the government's expected 2.3%, the Gross Fiscal Deficit for all States will be 2.7% of GDP.
• The analysis is based on budget projections from 18 States, which account for under 80% of the Indian GDP overall.
• The sharp decline in oil prices and the ensuing decrease in value-added tax receipts for state governments are to blame for the budget deficit.
• The UDAY (Ujwal DISCOM Assurance Yojana) interest charge and the wage increases due to the pay commission's awards would fall this year on the heads of the state governments.
• According to the government's estimate of 2.6 percent, the GDF may drop to 2.9% this year.
• According to study estimates, interest payments might cost the United States 0.1% of GDP in 2016–17.
• Six of the eighteen States, including Haryana and Andhra Pradesh, have budgeted for salary increases.

Fiscal Responsibility & Budget Management (FRBM) Act

The FRBM Act, enacted in 2003, establishes a target for the government to reduce the fiscal deficit. Its goal is to bring transparency to India’s fiscal management systems.

The Act’s long-term goal is for India to attain financial stability and to provide flexibility to the Reserve Bank of India (RBI) in dealing with inflation in India.

The FRBM Act was passed to achieve a more equitable distribution of India’s debt over time.

The FRBM Act’s Key Features are given below

• The FRBM Act required the government to submit the following documents to Parliament each year, together with the Union Budget:
  • Statement of Medium-Term Fiscal Policy
  • Statement on the Macroeconomic Framework
  • Statement of Fiscal Policy Strategy
• In the medium-term fiscal policy statement, the FRBM Act suggested that the revenue shortfall, fiscal deficit, tax revenue, and total outstanding liabilities be anticipated as a percentage of GDP.

Conclusion

The fiscal deficit must be cut down by reducing government spending or increasing revenue. This can be achieved by increasing taxes or cutting spending on social welfare programs, aid to states, military budget, etc. But cutting down on expenses and increasing taxes has political and social implications; therefore, it is easier said than done.

UPSC Previous Year Mains Question

Q1. What were the reasons for the introduction of the Fiscal Responsibility and Budget Management (FRBM) Act, 2013? Discuss critically its salient features and their effectiveness. (2013)

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