DEFICIT FINANCING (DF)
Terms
·
Crowding out- excessive govt. borrowings can lead to
shrinkage of liquidity in market, forces the interest to go up
·
private investment is crowd out for two
reasons:
1.
Liquidity
availability is less
2.
The
interest rates are high
·
Investment suffers & growth
decelerates. The
govt. also may not spend the borrowed resources well to generate returns if the
govt. deploys the funds well, it may have crowding a multiplier effect on
investment, tax collection & control.
·
Fiscal Drag: A situation where inflation
pushes income into higher tax brackets, the result in increase in income tax
but no increase in real purchasing power. This is a problem during periods of
high inflation govt. gains due to higher tax collection & the economy suffers
as the growth is dragged down due to less demand.
·
Pump Priming: Deficit financing & spending
by a govt. on public works in an attempt to revive economy during recession. It
can raise the purchasing power of people thus stimulate & revive economic
activity to the point that deficit spending will no longer be considered
necessary to maintain the desired economic activity.
·
Giffin Goods/: They include goods whose demand
goes up when the prices increases. They are the status markers & exclusivist
in nature.
·
Inferior Goods- those
goods whose demand decreases with an increase in the consumer’s income
Income effect outweighs the
substitution
effect
·
A
giffen good occurs when a rise in price causes higher demand because the income
effect outweighs the substitution effect. A
giffen good occurs when a rise in price causes higher demand because the income
effect outweighs the substitution effect. (positive-sloped
demand curve for Giffen goods)
·
Demerit Goods are those whose consumption
should be discourages. They have extranalities – six goods called by 13th
finance commission & want to be harshly taxed.
Deficit
Financing (DF)
·
The
term becomes popular in 1930 in the wake of great depression & J.M. Keynes
became ardent advocate of DF.
·
DF is financing of deliberately created gap
between revenue & expenditure.
How is deficit financed?
·
Borrowing
within the country
·
Borrowing
from outside the country
·
Govt.
can borrow from central bank
·
Govt.
itself can issue new currency
·
Drawing
down on cash reserve by govt.
·
Largely
in developed countries DF is done with first option which does not lead to
increase in money supply
·
In
developing country largely do DF through central bank this lead to addition in
money supply.
In India following ways are used
to finance DF
1.
By running down its accumulated
cash reserve from RBI.
2.
Borrowing from reserve bank of
India
3.
Borrowing
within the country
4. Borrowing from outside the
country
Note
·
Indian government do not finance
by printing new note
·
But Finance minister GOYAL has
proposed to finance by monetized method as in case of USA
Deficit financing
Two types
·
Both
method presuppose that the government is unwilling or unable to raise tax
revenues to balance its budget.
Debt financing –
·
governments sell
bonds either domestically or internationally to plug the gap between revenue
and expenditure
Monetized financing -
·
By
“printing currency
Money finance
·
is
possible because of what is known as “seigniorage"—the profit the central
bank makes as the monopoly provider of fiat currency.
·
In
simple terms, a newly printed ₹100 note can be used to purchase goods and
services worth ₹100, but the cost of producing it is negligible in terms
of paper, ink and manpower. In that margin lies the profit.
Fiat money
·
is
government-issued currency that isn't backed by a commodity such
as gold.
Adverse effects of DF
·
Inflation
is representative of DF.
·
Adverse
impact on balance of payment :
o People who are investing in India
will run off as with increase in inflation money supply will increase &
rupee will depreciate.
o People will resort to imports
will lead to high current account deficit which put down pressure on exchange rate.
o It can lead to wage price spiral
(inflation) price increases lead to higher wage demand & money in hand of
employees would increase this will further lead to increase in prices.
Forced Saving:
·
People
who can least save are made to save which lead to low standard of living.
·
Long
term lending is discourage
·
Pressure
of efficiency in production is reduced
·
Changes
in pattern of govt. investment:-
Private
investment are often channelized into areas which may not necessarily be
priority areas e.g. investment in allied goods.
Positive effects or objectives of
DF
·
It
can help in war time financing
·
It
is a remedy for depression
·
It
can help in economic development of under developed countries
·
It
can access capital formation
·
Inflation
resulting from DF can encourage private investment because it creates sometime
money illusion.
What measures can be taken to
control the adverse effects of DF
1.
DF
resources should be used in remunerative activities as far as possible.
2.
Appropriate
co-ordination between fiscal & monetary policy i.e. use of monetary tools
to mop up the additional purchasing power of the economy.
3.
Check
hoarding, black marketing etc.
4.
Increase
production in the economy
5.
New
money into unrealized capacity which would immediately increase production
& to an extent check price rise.
DF in developed & developing
countries
·
In
developed countries even if DF is made in a manner it increases supply of money
yet the inflation would not increase much as in developing countries because in
developed countries there may be expansion which takes much lesser time.
·
In developing countries the choice is limited
other higher inflation high growth, low inflation low growth so first option is
adopted.
Types of Deficit
1. Budgetary
Deficit:
·
This
is the difference between total budgeted expenditure & total budgeted
revenue.
·
This was abolished in 1997 because it
considers the govt. borrowings in calculation of budgeted deficit.
2. Fiscal
Deficit:
·
Difference
between total expenditure on one hand & revenue receipts & capital
receipts (which are not in nature of borrowing) (e.g. sale through
disinvestment, grants)
·
Fiscal
deficit is defined as excess of total budget expenditure over total budget
receipts excluding borrowings during a fiscal year. In simple words, it is
amount of borrowing the government has to resort to meet its expenses.
·
A large deficit means a large amount of
borrowing.
·
FD
is reflective of the total borrowing requirements of Government.
·
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=budget deficit + govt. market borrowings &liabilities
Fiscal deficit = Total expenditure – Total receipts
excluding borrowings
FD = Total Expenditure – (Revenue receipts + Non
Debt Capital Receipts).
3. Revenue
Deficit:
·
This
is the difference between total revenue expenditure & total revenue
receipts
·
given the same level of fiscal deficit, a
higher revenue deficit is worse than a lower one as revenue deficit implies a
payment burden not matched by any future returns.
4. Primary Deficit:
·
This
is (fiscal deficit - interest payments).
·
It indicates that how much of govt. borrowing
is going to meet the expenditure other than interest payments.
·
In
other words whereas fiscal deficit indicates borrowing requirement inclusive of
interest payment, primary deficit indicates borrowing requirement exclusive of
interest payment (i.e., amount of loan).
·
It
excludes the burden of the past debt and shows the net increase in the
government’s indebtedness due to the current year’s fiscal operations
5. Monetized
Deficit:
·
This
is deficit financing made from RBI through printing fresh currency.
6. Effective
Revenue Deficit (ERD):
·
(introduced
in 2012 budgets by amending fiscal responsibility budget management act 2003).
·
Revenue
Deficit minus grants for creation of assets given to states.
7. Twin
Deficit: When a
country simultaneously has a large current account deficit & a fiscal
deficit is known as twin deficit double deficit.
|
BUDGET
2017-18
|
2017-178
|
2018-19
|
2018-19
RE
|
2019-20-
BE
|
|
Revenue
Deficit
|
(2.6)
|
2.2
|
2.2
|
2.3
|
|
Effective
Revenue
|
1.5
|
1.2
|
1.1
|
1.3
|
|
Fiscal
Deficit
|
3.5
|
3.3
|
3.4
|
3.3
|
|
Primary
Deficit
|
0.4
|
0.3
|
0.2
|
0.2
|
Deficit Financing in India
·
India
required high doses of public debt & deficit financing.
·
In
1st five year plan govt. resorted to moderate doses of deficit
financing.
·
In 2nd 5 year plan planners wanted
to raise deficit financing upto 25% which lead to severe inflationary potential
& this further supplemented by two wars & than govt. decided to put
limit on deficit financing since 3rd 5 year plan.
·
But
regularly govt. exceeds its target as in 8th 5 year plan 20000 crore
was target but actual deficit financing was 63000 crore.
·
The
enactment of fiscal reforms & budget management act (FRBM 2003), the fiscal
deficit of central govt. declined to 3.5% of GDP in 2006-07 & further reduced
to 2.5% of GDP in 2007-08.
·
However because of slow down in economy &
govt. stimuli packages, fiscal deficit increased to 6.5 in GDP in 2009-10.
·
After
declining to 4.9% of GDP in 2010-11 it again rose to 5.7% of GDP in 2011-12
& then again decreased to 5.2% of GDP in 2012-13 & in financial year in
2013-14 it is contained to 4.5% of GDP.
·
In
2014-15 Fiscal deficit was 4.1% of GDP
·
In
2015-16 Fiscal deficit was 3.9% of GDP
·
In
2016-17 Fiscal deficit was 3.5% of GDP
·
In
2017-18 Fiscal deficit was 3.5% of GDP
·
In
2018-19 Fiscal deficit was 3.4% of GDP
As
per budget 2019-20-
·
Fiscal
deficit and revenue deficit are at 103 percent of BE and 107 percent of the BE
respectively in the year 2018-19.
·
The
revised estimates place fiscal and revenue deficits at 3.3 percent of GDP and
2.3 percent of GDP respectively in 2019-20.
·
Although
in India huge funds are required for socio-economic activity but in a way
deficit financing is done is not justified.
·
The
minor deviation in the path of FD as ordained by the Act has been necessitated
by two main factors,
·
transitional
impact of GST and
·
the
agricultural situation in the country
The Fiscal Responsibility and Budget
Management (FRBM) Act was legislated by the Parliament in the year 2003.
Objectives of the FRBM Act
·
Maintain
transparency in fiscal management system in the country
·
Keep
a check on governments living beyond their means to reduce debt burden on
future generations.
·
Restrict
uncontrolled government borrowings as it crowds out private investments,
increases inflation or leads to balance of payments deficit, thereby causing
macroeconomic instability.
·
Do
away with impediments to enable the RBI frame an effective monetary policy and
control inflation.
Main provisions of the original
act
The
act stipulates the Union government to-
·
Annually
reduce revenue deficit by 0.5% and eliminate it wholly by 2008-09
·
Annually
reduce fiscal deficit by 0.3% and bring it down to 3% of GDP by 2008-09
·
Not
give guarantee to loans acquired by PSUs and state governments for over 0.5% of
the GDP in a financial year
·
Present
three additional documents along
with the annual budget, namely
1.
the Macroeconomic Framework Statement,
2.
the Medium Term Fiscal Policy Statement and
3.
the
Fiscal Policy Strategy Statement.
·
Cease
borrowing directly from the RBI from 2006.
Suspension
of the act and efforts for its reestablishment
·
Due
to the global financial crisis in 2008, the deadlines for the implementation of
the fiscal consolidation targets were temporarily suspended.
·
As
a result, fiscal deficit increased to 6.2% of GDP in FY09 as against the target
of 3% set by the Act for FY09 period.
·
However, the crisis necessitated an increase
in government expenditure in order to boost demand in the economy.
Amendments
made to the original FRBM Act
·
Later
through the 13th Finance Commission and the Finance Act 2012, following were
the amendments made:-
·
In
2012, besides the three documents, the Centre should present the Medium Term
Expenditure Framework Statement (MTEF).
·
This
sets forth a three-year rolling target for expenditure indicators, specifying
underlying assumptions and risks involved.
·
Effective revenue deficit (difference between revenue
deficit and grants for creation of capital assets) was made a new fiscal
parameter.
·
With the Finance Act 2015, the target dates
for achieving the approved effective deficit and fiscal deficit rates were
further extended.
·
The
effective revenue deficit, which had to be eliminated by March 2015, will now
need to be eliminated by March 2018.
·
The 3% target of fiscal deficit
to be achieved by 2016-17 has now been shifted by one more year to the end of
2017-18.(in budget 2019-20 it shifted to march 2021)
Note
·
The
finance ministry announced formation of a five-member committee to review
Fiscal Responsibility and Budget Management (FRBM) Act. (may 2016)
·
The
committee, headed by former revenue and expenditure secretary NK
Singh, will review the working of the FRBM Act over the last 12 years
along with examining the feasibility of having a fiscal deficit range instead
of a fixed number as a percentage of gross domestic product at present.
NK
Singh committee on Fiscal Responsibility and Budget Management (FRBM to review
it
·
The Committee
has favoured Debt
to GDP of 60%
for the
General Government by
2023, consisting of
40% for Central
Government and 20%
for State Governments
·
Within this
framework, the Committee
has derived and recommended 3%
fiscal deficit for
the next three years.
·
The
Committee has also provided for ‘Escape Clauses’, for deviations upto 0.5%
of GDP, from
the stipulated fiscal
deficit target.
·
The
central government should reduce its revenue deficit steadily by 0.25
percentage (of GDP) points each year, to reach 0.8% by 2023, from a projected
value of 2.3% in 2017.
·
It
suggested the setting up of a ‘fiscal council’, an independent body which will
be tasked with monitoring the government’s fiscal announcements for any given
year.
The
Government has amended the Fiscal Reforms and Budget Management Act, 2003 vide
Finance Act 2018 (Act 13 of 2018). The key recommendations of Shri NK Singh
Committee were accepted by the Government.
Medium-term
debt
·
It
has been decided to achieve a target of 60 per cent of GDP for General
Government Debt and 40 percent of GDP for Central Government Debt by March
31st, 2025
Fiscal
Deficit (FD) only be parameter
·
Fiscal
Deficit (FD) has been adopted as the only operational target for fiscal
consolidation. FD has been targeted at 3 percent of GDP by March 31st, 2021.
·
Revenue
Deficit and Effective Revenue Deficit have been removed as parameters for targeting
fiscal outcomes
Escape
clause and buoyancy clause
·
to
allow deviation from FD targets in the event of rare / unforeseen events.
·
This will provide sufficient flexibility for
necessary deviations to enhance the credibility of fiscal rule while preventing
violation of these rules.
Deviation
allowed of .5%
·
Further,
in keeping with the provisions under Section 4(3) of the FRBM Act, it has been
ensured that the deviation from fiscal deficit target shall be within the
prescribed and allowed limit of the Act of 0.5% of GDP
State government finances
·
The
RBI study on State Finances points to the deterioration in fiscal deficit to
GDP ratio in 2017-18 RE when compared to the budget estimate
·
This
deterioration occurred due to the overshooting of revenue expenditure mainly
due to farm loan waiver and pay revisions
·
States
have budgeted for fiscal deficit of 2.6 per cent of GDP in 2018-19 BE.
·
the
outstanding liabilities of states, as per cent of GDP, has increased after
2014-15.
·
The
issuance of UDAY bonds in 2015-16 and 2016-17, farm loan waivers, and the
implementation of pay commission awards have led to higher debt to GDP ratio
·
Economic
Survey 2016-17 had estimated impact of UDAY bonds on fiscal deficit to be 0.7
percentage points of GDP. However, despite rising States’ debt to GDP ratio,
interest payment as proportion of revenue receipts has not deteriorated
·
The
fiscal deficit of General Government is further expected to decline from 6.4
per cent of GDP in 2017-18 RE to 5.8 per cent of GDP in 2018-19 BE
·
It
can be concluded that The General Government (Centre plus States) has been on
the path of fiscal consolidation and fiscal discipline.
