What is Fiscal Deficit? Meaning, Formula & Impact

The gap between a government’s total spending (expenditure) and its total income (revenue), excluding borrowings, is the fiscal deficit for the financial year. It indicates an additional capital requirement of the government when it plans to spend more than its yearly earnings. However, borrowing affects the economy, lending rates, inflation, and investors. So, fiscal deficit should be within a certain limit. This article explores what is fiscal deficit meaning and its impact in detail. 

How is the Fiscal Deficit Calculated in India?

The fiscal deficit can be computed by examining the gap existing between what is spent and what is received in revenues, to the exclusion of borrowing. The formula used is: 

Fiscal Deficit = Total Expenditure − Total Receipts (excluding borrowings) 

What this includes: 

• Total Expenditure: Revenue expenditure (salaries, subsidies, interest) plus capital expenditure (roads, railways, infrastructure). 
• Total Receipts (excluding borrowings): Revenue receipts (tax and non-tax income) plus non-debt capital receipts (like disinvestment or recovery of loans). 

Simple example 

Let’s say in one financial year: 

• Total Expenditure = ₹30 lakh crore 
• Revenue Receipts = ₹22 lakh crore 
• Non-Debt Capital Receipts = ₹2 lakh crore 

Total Receipts (excluding borrowings) = ₹24 lakh crore 

 So, 

Fiscal Deficit = 30 − 24 = ₹6 lakh crore 

This ₹6 lakh crore is the amount the government needs to borrow.  

What Causes Fiscal Deficit? 

A fiscal deficit occurs when a government's total expenditures exceed the revenue it generates (excluding borrowing). Let us understand the causes of fiscal deficit: 

• High Government Spending: Excessive government spending on public services, infrastructure, defence, or welfare programs can lead to a fiscal deficit if it's not matched by revenue. 
• Low Tax Revenue: When a government fails to collect enough taxes due to inefficiencies, lower economic activity, or tax evasion, it can struggle to meet its spending needs. 
• Debt Servicing: High-interest payments on existing government debt can consume a large portion of the budget, contributing to a fiscal deficit. 
• Economic Slowdown: During periods of economic recession or slowdown, tax revenue drops, but government spending may rise to stimulate the economy, increasing the deficit. 
• Unplanned Expenditures: Emergency expenses like natural disaster relief, sudden military operations, or financial bailouts can lead to unforeseen spending, pushing the government into a deficit. 
• Tax Cuts Without Spending Cuts: If the government reduces taxes without simultaneously cutting its expenditures, it can result in a shortfall between income and spending, causing a fiscal deficit. 

Key Components of Fiscal Deficit 

After understanding what is the definition and meaning of fiscal deficit, let’s look at it components. A fiscal deficit occurs when a government’s total expenditure exceeds its total revenue (excluding borrowings). Here are the key components: 

• Government Expenditure: This includes all spending by the government on goods, services, infrastructure, welfare programs, defence, and salaries. 
• Revenue Receipts: These are the funds collected by the government through taxes (like income tax, corporate tax, and VAT) and non-tax revenues (like fees, fines, and interest on loans). 
• Capital Expenditure: A part of government expenditure, refers to spending on long-term investments, like infrastructure and machinery, that will help the economy in the future. 
• Revenue Deficit: This is the shortfall between the government’s current revenue and its current expenditure. It is an important contributor to the fiscal deficit. 
• Borrowings: To finance the fiscal deficit, the government borrows from domestic and international markets by issuing bonds or taking loans. 
• Public Debt: This includes all the borrowings that the government has accumulated over time, adding to the fiscal deficit when the government fails to balance its budget through revenue generation alone.  

Why is the Fiscal Deficit in India Important for the Economy? 

A fiscal deficit is an important indicator of a country's economic health. Below are the reasons why it is significant: 

• Measures Government Borrowing: A fiscal deficit shows how much the government is borrowing to meet its expenditure, helping to understand its financial stability. 
• Indicates Economic Stress: A high fiscal deficit can signal that the government is overspending, which could lead to inflation or increased national debt. 
• Affects Interest Rates: If the government borrows heavily, it can push up interest rates, making borrowing more expensive for businesses and individuals. 
• Impacts Inflation: Excessive borrowing may lead to an increase in the money supply, potentially causing inflation, which reduces the purchasing power of citizens. 
• Credit Rating and Investor Confidence: A rising fiscal deficit can affect the country's credit rating, making it harder to attract investment and potentially raising the cost of borrowing internationally. 

How Does the Government Balance the Fiscal Deficit in India? 

Here is how the government typically balances the fiscal deficit: 

• Increase Tax Revenue: The government can raise taxes or improve tax collection to increase its income, helping to cover the deficit. 
• Cutting Public Spending: Reducing government expenditure, especially on non-essential services or subsidies, can help lower the deficit. 
• Borrowing: The government may borrow money through bonds or loans from domestic or international lenders to finance its deficit temporarily. 
• Privatisation: Selling government-owned assets or enterprises can generate income to reduce the deficit. 
• Boost Economic Growth: Promoting policies that stimulate economic growth increases overall tax revenue, helping to reduce the deficit over time. 
• Inflation Control: Managing inflation ensures that government debt does not become harder to repay due to rising costs, indirectly helping manage the deficit. 

Effective Strategies to Offset Fiscal Imbalances 

To offset fiscal imbalances, below are the following strategies are provided: 

• Increase Tax Revenue: Raise taxes or improve tax compliance to boost government income, ensuring more funds for public spending. 
• Cut Public Spending: Reduce government expenditures, particularly in areas like wasteful subsidies or inefficient programs, to help balance the budget. 
• Debt Restructuring: Negotiate better terms on existing debt to reduce interest payments or extend repayment periods, easing fiscal pressure. 
• Promote Economic Growth: Stimulate the economy through investments in infrastructure, innovation, or job creation, which leads to higher tax revenue over time. 
• Privatisation of State Assets: Sell or lease government-owned assets to generate one-time revenue and reduce the fiscal burden. 
• Improve Public Sector Efficiency: Streamline government operations and reduce bureaucratic inefficiencies to lower costs without compromising services. 

Fiscal Deficit vs Revenue Deficit vs Primary Deficit  

Here are the differences between fiscal deficit, revenue deficit, and primary deficit: 

Advantages and Disadvantages of Fiscal Deficit  

Conclusion 

A fiscal deficit refers to the difference between government spending and earnings over a fiscal year. It is of significance in that, in addition to budgeting, it dictates borrowing decisions and choices of economic policies. While it may be small enough to accommodate economic growth and development, it might sometimes be too large, according to economists, and translate into higher levels of debt with negative implications for stability. It also impacts interest rates, inflation, and, more importantly, market sentiment toward the economy. Keeping tabbed on these indicators and their market impact through regular updates, many investors seek help from some dependable stock market app.