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What is Fiscal Deficit and how it affects Economic Growth of the Country?

If your salary is 30,000 Rs. per month but your estimated monthly expenses are 35,000 Rs. then 5,000 Rs. is your ‘deficit’. So, how would you manage? You have four options:

  1. Either borrow money from your friends and pay interest on that.

  2. Cut your spendings.

  3. Request for a salary hike.

  4. Print money. ( which of-course you can’t do).

In case you borrow money, the lender friend will begin to doubt your ability to repay as you have less earnings. If you’l cut your spending then may be you spouse will begin to doubt your ability to take care of your family financially. In case you request a salary hike then your boss may reject the offer or may increase your working house which is ultimately undesirable. Don’t even dare to think about the fourth option. Total mess!

Now think about the government, You have only one family to take care of but government has millions of family to take care of.

Government Expenditure:

In India there are almost 35 major industries that government should take care of:

In all these industries government has to infuse capital in order to increase growth and production.

More Capital Infuse > Increase in production > More jobs will be created > More Corporate earnings > Better earnings > Better economic growth.

Government Income:

So in this case we can say that Government must have good earning source too. So what are the income source of India Government?

  1. Tax ( Major income).

  2. Interest Receipts ( Mainly on the loans it has advanced to State Governments).

  3. Surplus Profits of the Reserve Bank of India (RBI):

  4. Currency, Coinage and Mint ( Mainly difference between the face value of the coins and their manufacturing cost.)

  5. Railways.

  6. Profits of Public Enterprises & Dividend ( BHEL, BEL, SAIL etc).

Now here we come to Fiscal deficit:

Now, In your case, you managed your deficit by borrowing money from your friend but in case of government. They have:

  1. Issuing bonds (In which they must pay interest on).

  2. Ask RBI to print more money.

  3. Raising Taxes. (Which is unfavorable to public)

  4. Cutting off Spending. (Which is again unfavorable to public).

Now the point is, How Fiscal deficit affects the economy? Well, Let’s take each cases discussed their individual effects in brief.

  • Issuing bonds: Government bonds come up with coupon, which they have to pay each year and at the end of the tenure, Government must give the principal money back to the lender. So, ultimately by issuing bonds, government is actually reducing short term pain and increasing long term pain.

  • Ask RBI to print more money: When government ask RBI to print more money then due to excess supply of cash in the market, Inflation comes to picture which actually depreciates the rupee value. So here we go,

RBI prints more money > Increased supply for money in the economy > High Inflation > RBI can’t reduce the interest rates

When interest rates are high, Corporate earning slows down as they can’t afford to pay such high taxes so they cut the jobs, and slow down the production.

Result : Low Corporate earnings > Less Production > Less jobs > Less spending ( as one person’s spending is another person’s income) > Economic crisis.

  • Raising Taxes: Whenever we talk about company’s bottom line then while calculating the net profit, we first determine EBITDA which is nothing but Earnings Before Interest Tax Depreciation and Amortization. So when Tax increases then a big goes out from the company earnings so bottom line very much affected. As per 2017 data, Only 1.7% of Indians Pay Income Taxes.

Results will be same as before: Low Corporate earnings > Less Production > Less jobs > Less spending ( as one person’s spending is another person’s income) > Economic crisis.

  • Cutting off Spending: Spending on distinct major sectors (which I have mentioned already) put a high pressure on production and growth ,which is very unpopular among all these options and government avoid this method.

As per the lastest report publish by DCA ,India’s fiscal deficit exceeded the halfway mark of its budgetary estimate two months into the new financial year. Fiscal deficit, the gap between the government’s revenue and expenditure, rose to Rs 3.45 lakh crore at the end of May, that’s 55.3 percent of the targeted Rs 6.24 lakh crore in 2018–19.

Fiscal Deficit is calculate as a % of GDP.

Source : Union Budget 2018–19.

The gap is lower than what it was in May last year, at 68.3 percent of the FY18 target, as the government had frontloaded expenditure to kickstart the investment cycle.

India’s finances were constrained then as it had to revise its deficit target upwards due to the implementation of the Goods and Services tax. It aims to keep the deficit within 3.3 percent of the country’s gross domestic product for FY19.

The government’s total expenditure for April-May rose to Rs 4.72 lakh crore, or 19.4 percent of the full-year target. Total revenue receipts stood at 7 percent of the target at Rs 4.09 lakh crore.

Bottomline: Fiscal deficit plays very important role in Country’s economic growth. Budget documents showed that the government is expecting a 16.7 percent rise in its gross tax revenue in FY19.

Akshay Seth Research Analyst (SEBI Regd.) Co-founder at Equityboxx.com invest@equityboxx.com linkedIn: www.linkedin.com/in/akshay-seth-1b7a1668

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