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.

3.

increase the amount of taxes collected by

increasingthetaxrates;
help stimulate economic growth so that tax
collectionautomaticallyincreaseswithit;or
print newcurrencynotes topaybackthedebt
alsocalleddebtmonetization.

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.

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)