How Revenue Deficit and Fiscal Deficit Impact the Economy?

See how Fiscal Deficit acts as the most crucial macroeconomic indicator of a nation's economic well-being.

Understanding Revenue Deficit and Fiscal Deficit

The government of any country incurs a lot of expenditure for the welfare of its citizens and for the purpose of meeting these expenses, it collects money from its citizens. This money is collected from various sources like Direct and Indirect Taxes, Sale of Assets etc. and the money so collected is called the Government’s revenue. 

If the expenses, which are incurred by the government for the welfare of the nation, are less than the revenue collected by it, this leads to a situation of a surplus wherein at the end of the year – some money is still left with the government. On the other hand, if the expenses incurred by the government are more than the revenue earned by it, this leads to a deficit wherein the government ends up spending more money than it has collected.

Deficit = Total Expenses – Total Receipts

Types of Deficit

There are various types of deficits, and the most important types of deficit are Revenue Deficit and Fiscal Deficit. Both these types of deficits are explained below in detail.

1. What is Revenue Deficit?

Revenue Deficit is the extra amount spent as revenue expenditure by the government as compared to its total revenue receipts. The important to note here that Revenue Deficit takes into consideration the items (i.e. both incomes + expenses) which are of revenue nature only but does not take into account the items which are of capital nature.

In other words, the income and expenses which are of recurring in nature are taken into consideration, but income and expenses which are of not of recurring in nature are not taken into account while computing the revenue deficit.

Revenue Deficit = Total Revenue Expenses – Total Revenue Receipts

Revenue Deficit signifies that the government's revenue receipts are not sufficient for it to undertake its revenue expenses and in such cases, the government resorts earning receipts which are of capital nature, i.e. Sale of Assets and Borrowings.

A revenue deficit warns the government that its current revenue receipts are not sufficient to carry out the revenue expenses and it should either curtail its expenses or increase revenue receipts. In case, the government is unable to undertake any of these; it will have to resort to the sale of capital assets or borrowings.

2. What is Fiscal Deficit?

Fiscal Deficit is the excess amount of total expenditure (Capital + Revenue) incurred as compared to its total receipts (Capital + Revenue). Fiscal deficit takes into account items which are of both capital and revenue in nature.

Fiscal Deficit = Total Expenses (Revenue + Capital) – Total Receipts (Revenue + Capital)

The fiscal deficit of the country gives an indication to the government about how much the government has to borrow to incur all these expenses which are over and above its collections. In other words, borrowings help the country meet its fiscal deficit.
 

Impact of these Deficits on the Economy

The deficit is a mathematical number arrived by the economists and has a huge impact on the economy of any country which directly affects its stock markets. 
If the country is in deficit, it indicates that the government’s earnings are less than the government’s expenses and the government has to rely on external borrowings. The government can do the same by:

  1. Printing more currency
  2. Seeking external borrowings

As more money enters the system, it will lead to higher demand for goods and services leading to higher inflation. Moreover, from the next year onwards, the government would also have to pay interest on these borrowings which will in-turn put more pressure on the government to increase its receipts. 

In 1996, a lot of industrial production capacity was lying idle in India due to lower demand. To stimulate and create demand, a fiscal deficit ensuring economic growth was recommended.

As India was a demand constraint economy for many years, the increase in demand did not put much inflationary pressure on the economy. The increase in public investments in infrastructure, highways, roads etc. was doubly beneficial from the viewpoint of accelerating economic growth. This not only helped in accelerating aggregate demand on one side and but also helped to reduce supply constraints on the economic growth on the other.

However, the economic situation in India has changed a lot since the nineties. Very few industries are facing demand issues, and the infrastructure facilities have also improved. Although both these need to be further enhanced, but the situation is not the same as it was in the nineties.

Any increase in fiscal deficit now will put a lot of inflationary pressure on the economy. Moreover, the public debt, has also increased so much that it is already putting a lot of pressure on the government as the interest outgo is also very large.

In the current situation, an increase in inflation also puts pressure on the household savings rate as the household expenses increase which directly impacts the savings. However, the fact that India needs to improve its infrastructure better and create better facilities for businesses to prosper can also not be ruled out.

Therefore, a fiscal deficit is not always bad. The plus point is that it leads to additional demand and the minus point is that if it is too large as it leads to inflation which is detrimental to the overall health of the economy.

A higher inflation rate leads to higher interest rates as a result of which businesses have to pay more interest to borrow which may result in lower profits. As the interest liability increases, some of the low-income businesses turn unviable and are forced to shut leading to lesser jobs.

Investors across the globe keep a close eye on the deficit of any country as it has a direct impact on the profitability of any company leading to an increase/decrease in the share price of the company.

A high debt level also impacts the credit rating of the country as it puts more pressure on the government. Therefore, ascertaining that optimum level of fiscal deficit is anybody's guess and an increase in the fiscal deficit above the optimum level is being seen as negative as it puts a lot of pressure on the economy.

India's current account deficit narrows to 2.5% of GDP. This fiscal deficit is calculated as a percentage of the GDP by subtracting the budgeted amount from the actual expense. If this expense goes over budget, then the result will be positive. Then the number is divided by the original budgeted amount and multiplied by 100 to get the percentage over budget.

-Karan Batra

"Karan Batra is a Chartered Accountant specialising in Income Tax and GST. He is the founder and CEO of charteredclub.com which is one of India's largest content platforms for Tax related resources. He is also a visiting faculty at the Institute of Chartered Accountants of India and has also authored 2 books on Capital Gains Tax and Presumptive Tax. 

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.
 

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