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The Effects of Fiscal Deficits

The Effects of Fiscal Deficits

Fiscal deficit is the difference between government expenditure and revenue. Know how it affects the economy.

A country’s economy is the pillar of its survival in this world. Without a strong economy, everything deteriorates in a country. Therefore, without a strong economy, a country will not be able to purchase goods or services, nor will it be able to make a good amount of profit on the exports that it makes to other countries.

The economy of a country is decided by two prime financial actions of the government. The first one is the revenue that the government generates through taxes, selling assets and so on and the second is the expenditure that the government makes to support its non-financial activities. This interplay between revenue generation and expenditure gives rise to the concept of fiscal deficit.

What is the Fiscal Deficit?

In layman’s terms, the fiscal deficit can be described as the difference between the expenditure and the revenue of the government. The fiscal deficit of a country can help economists gauge how the country will fare in the upcoming fiscal year. A fiscal deficit is not just the difference between the revenue and the expenditure of the country, but it is when the country’s expenditure is more than the country’s revenue that we call a country to be in a fiscal deficit.

The fiscal deficit also gives an idea of how much the country will have to borrow from other countries in order to offset the fiscal deficit in its economy. Usually, fiscal deficits are prevalent in almost all countries. This is because all countries are involved in their development, and hence the expenditures of a country will always be higher than its revenue. 

The revenue that the Indian government generates primarily relies on taxes like the GST, custom duties, income tax and so on. Whereas, the expenditure of the government is primarily on public projects, schemes and other such non-financial activities that usually generate almost no income for the government. Therefore, it becomes very easy for a country to be in a fiscal deficit.

Types of Deficit in an Economy

A country can be in different types of deficit, and each deficit can affect the economy in different manners. Fiscal deficit is also an indicator of various other economic indicators like price stability, inflation etc. The three types of fiscal deficit that a country can find itself in are:

1. Revenue Deficit: When the total revenue expenditure done by the government is more than the revenue receipts held by the government, then a situation arises in which the economy is said to be in revenue deficit. In such a situation, the government is rendered incapable of maintaining its day to day tasks. In order to keep in operation, the government usually borrows money or undertakes divestments or introduces more taxes to generate more revenue.

2. Fiscal deficit: The negative balance that is generated in the economy when the country spends more than the money it makes is called a fiscal deficit. The fiscal deficit of a country is especially observed during the budget meetings since it can affect various other factors of the economy like growth, price stability and inflation in the country. If a country remains in fiscal deficit for too long, then the rating of the country may also go down compared to its foreign counterparts.

3. Primary deficit: Every borrowing of money leads to the payment of interest over the money that the country has borrowed. The money that the government borrows to pay off this interest is called the primary deficit. The primary deficit is a measure of the recovery of the fiscal health of the country as a decrease in the primary deficit directly correlates to an increase in the fiscal health of the country.

Effect of Fiscal Deficit on Economy

There are two broad effects of the fiscal deficit on the economy as judged by economists. On the one hand, economists stand by the fact that fiscal deficits boost a sluggish economy. This is because when there is a fiscal deficit there is more money in the market. Hence there are more opportunities for businesses to expand and generate more revenue. This leads to more government revenue and hence less fiscal deficit.

On the other hand, economists also believe that a long term fiscal deficit means that the country does not have enough resources to take care of its growing expenditure. This can mean that the price of commodities in the country can rise. That is a high amount of inflation can occur. The production costs of goods can also rise since imports in the country also reduce if there is a high amount of outstanding fiscal deficit in the country.

The continued borrowing by the country to offset the fiscal deficit but reduced printing of notes can also lead to increased pressure on the economy. But the fiscal deficit can also be offset if the expenditure that is made by the government is on productive investments that can take care of both supply and demand. Then the government expenditure can be offset by a small amount from the revenue that is generated from this investment.

Conclusion

The above article explains the effect of fiscal deficits on the economy. It is defined as the difference between the expenditure and revenue of the government. Further, there is also a description of the three types of deficit- revenue deficit, fiscal deficit and primary deficit. Lastly, there is a complete explaining of the effect of fiscal deficit on the economy.