WhatisaFiscalDeficit?

Andwhyyoushouldcareaboutit...
IntheUnionBudgetpresentedinParliamenton6thJulythis year,FinanceMinisterPranabMukherjeeannouncedthat ..thefiscaldeficitasapercentageofGDPisprojectedat 6.8%comparedto2.5%inBE200809and6.2%asper provisional accounts 200809. This level of deficit is a matterofconcernandGovernmentwilladdressthisissuein rightearnest. We've all heard about it and we've all read articles that worryaboutalargefiscaldeficit,whetherinIndiaorinthe UnitedStates.Butthequestionis,whatistheproblemwith abigfiscaldeficit?Indeed,whatisittobeginwith? Everyyear,theGovernmentputsoutaplanforit'sincome andexpenditureforthecomingyear.Thisis,ofcourse,the annual Union Budget. A budget is said to have a fiscal deficit when the Government's expenditure exceeds it's income. When this happens, the Government needs additional funds. Now there are two ways for the Governmenttoarrangethesefunds.Thefirstis,ofcourse, to borrow. The Government can borrow either from the citizensthemselvesorfromothercountriesororganisations liketheWorldBankortheIMF.Themoneyborrowedbya nation'sGovernmentiscalledpublicdebt.Asonanyother debt, the Government promises to pay a certain rate of interest.Topaythisinterestinthefuture,theGovernment hasthreeoptions: 1. 2. increase the amount of taxes collected by increasingthetaxrates; help stimulate economic growth so that tax collectionautomaticallyincreaseswithit;or print newcurrencynotes topaybackthedebt alsocalleddebtmonetization.

Now suppose that to repay some of it's debt, the Governmentdecidestoprintsomenewcurrencynotes.Say theGovernmentprintsnewnotesworthRs.10lacs.This means theamountofmoneyavailabletospendincreases from Rs. 1 crore to Rs. 1.1 crores. Since the amount of wheatproducedhasn'tincreased,eachtonneofwheatnow costs Rs. 1,100, a 10% increase! (1.1 crores paid for ten thousandquintals=Rs.1,100perquintal).Sowehavejust seenthattheeffectofdebtmonetizationisinflation,which actslikeaninvisibletaxonallthepeopleofacountry. Sodoes thatmeanthat fiscal deficitsareevil?Well,not necessarily.IfthemoneythattheGovernmenthadborrowed wasusedtoincreasetheamountofwheatproduction,then the inflation could have been avoided. To see how, we assumethattheGovernmentusedtheborrowedmoneyto improvetheirrigationfacilitiesinthecountry.Alsosuppose thatthisprogrammeledtoanincreaseinwheatproduction from10,000quintalsto11,000quintals.Inthatcase,even withanincreaseofmoneyto1.1crores,thecostofwheat wouldremain steady at Rs.1,000per quintal. Thus we'd haveeconomicgrowthandalsoavoidinflation.Everybody wouldbebetteroff.Clearlythen,itwasagoodthingthat the Government borrowed money to implement this programme. Itisthusclearthatafiscaldeficitisnotnecessarilyabad thing.However,alargeandpersistentfiscaldeficitcanbe anindicationofseveralworryingsignsintheeconomy.It can mean that the Government is spending money on unproductiveprogrammeswhichdonotincreaseeconomic productivity. It can also mean that the tax collection machineryisnoteffectivesothatasignificantproportionof peoplegetawaywithoutpayingtheirduetaxes.Inanycase, alargefiscaldeficitsignificantlyincreasesthechancesof inflationintheeconomywhichisaninvisibletaxonevery citizen. In extreme conditions, inflation can give way to hyperinflation that can completely destroy a country. In milderforms,highinflationandalargefiscaldeficitleadto aweakernationalcurrency(importsbecomeexpensive)and reducethecreditworthinessofthecountry. Ascitizens,therefore,wemustnotonlypayattentiontothe fiscaldeficit,wemustalsotryandunderstandthedifferent areas of Government spending. Is the Government borrowing money to spend on programmes that lead to increased economic productivity or is it spending on unproductiveprogrammes.Remember,evendirectlygiving money(oramenities)tosectionsofpeople,withoutcreating conditionsforthemtobemoreeconomicallyproductiveis dangerousbecauseofthereasonsseenabove. Vigilant,always! ParijatGarg (parijat@governindia.org)

3.

Wecanallagreethatthefirstoptionisnotdesirable.That leaves the second and third options. While the second optionsoundslikethebestone,itiseasiersaidthandone. Wewillseepresentlywhythethirdoptionisdangerousand canactlikeanunfairandinvisibletaxonthepeopleofa country.Todoso,wewillbeginwithaverysimplemodel ofanationaleconomy. Suppose that there is only one commodity that everyone needstobuyinordertoliveagoodlifesaywheat.Also, assumethatourcountryproducestenthousandquintalsof wheateveryyear.Thereareatotaloftwentyfivethousand peopleinthecountrywhospendRs.400eachperyearto buywheat.Thustotalamountofmoneyspenttobuywheat isRs.1crore.SincethisRs.1croreisspenttopurchaseten thousandquintalsofwheat,thecostofwheatisRs.1,000 perquintal.