The fiscal deficit reflects the resource gap of the government - the excess of total expenditure over grants and revenues. Since the government spends more than it earns, it needs to finance this gap. As in case with corporations, the gap is funded by borrowed funds from internal or external sources. Thus, fiscal deficit indicates the total indebtness of the government.
Taxes (direct and indirect) are the primary source of revenue for the government. The expenditure side is represented by plan and nonplan expenditure. Plan expenditure can be loosely associated with capital spending, mainly on infrastructure to boost growth in the economy. Non-plan expenditure includes non-productive but necessary expenditure on defense, subsidies, administration and debt servicing (interest). The difference between the expenditure and revenues is met through deficit financing.
It was during the great depression of 1930s that the concept of deficit financing came in to recognition. In simple terms, deficit financing is "the financing of deliberately created gap between public revenue and public expenditure or a budgetary deficit, the method of financing resorted to being borrowing of a type that results in net addition to the national outlay or aggregate expenditure".
In a developing country like India where the government fails to generate enough revenues to meet its burgeoning expenses, recourse to deficit financing becomes important. It is argued that such a deficit to the extent incurred on developmental activities generates additional demand and this, in turn boosts industrial production and business activity.
However, a disproportionate rise in money supply creates inflationary problems for the economy. Because of rising price levels, the level of consumption of the people whose income rises less than proportionately falls in 'real' terms i.e. the same amount of money now buys fewer goods. Moreover, large-scale fiscal deficit financing results in transfer of resources from private sector to public sector.
Ideally, deficit financing should only be used to fund productive expenditure so that these investments generate income streams in the future, which will help repay the debt. However, this is not the case with India. The expenditure pie of the government is titled towards non-plan or unproductive expenditures of the government and hence most of financing is consumed towards meeting these expenses.
Unproductive expenses consuming resources!
||Non Plan Exp.(%)
Uncontrolled rise in non-plan expenditure and failure to tap a parallel-unaccounted economy for fuelling in tax revenues over the last decade has further worsened the fiscal position. As against 31% share of plan expenditure in 1993-94, this has dropped to less than 27% in 2001-02. The most disturbing fact is that more than 30% of the non-plan expenditures goes towards interest payments. In China, a better control over non-plan expenditure has resulted in tighter control over the deficit position inspite of lower tax to GDP ratio.
Fiscal Position- India vs. China
(All the above figures are based on 2000 numbers) *- Combined deficit of center and state.
|% of GDP
|Total Tax revenues
|Gross Domestic Savings
A decade of reforms and the government’s precarious position in 1990s seems to have come a full circle from an alarming 6.1% fiscal deficit 1990s. Last year, the government overshot its target and ended the year with 5.1% deficit. In the current year, inspite of higher taxation, tapping new avenues and ambitious divestment targets, the government is expected to end the year with a 5.7% deficit.
The government would probably find some comfort in the current year on account of interest outgo due to falling rates. On the revenue side, the government seems to be making a desperate attempt to mop up additional tax revenues.
However, having tapped most of the possible avenues, the government does not seem to have breathing space to target further new avenues going forward. While the country is in desperate need to create additional infrastructure, through plan expenditure, controlling non-plan expenditures probably seems the only possible way to keep a likely debt trap away. We need the fiscal responsibility bill to be implemented more aggressively.