Market Insights5 Mins Read
What Is ‘Fiscal Deficit’ And How Does It Impact You?
For the common wo/man on the street
We just had the FM present the budget for the year 2020 – 21 and everyone is talking about it. Budgets have gained significant prominence among the general public due to the direct impact, taxation (Income Tax rates) have on the largely salaried middle class. While most are talking about the new, lower slabs introduced under the Income Tax and how they may or may not be useful, I thought of writing on another very important piece of the budget – Fiscal deficit.
Though this may not directly impact ordinary folks like you & me, but it does play a very critical role in shaping economic decisions & economic growth (or the lack of it) in the longer term.
Fiscal deficit, over a period of time, plays a crucial catalyst role in determining interest rates in the country. And interest rates, as we all know, play a critical role in our individual and collective lives.
I will quickly explain, in as simple a language as possible, what fiscal deficit is and how does it impact interest rates.
Fiscal deficit, very simply put is the difference between a government’s total revenue and total expenditure in a year. The government earns revenue primarily through taxes collected – direct & indirect and spends it on building infrastructure – rail, roads, highways, public transport, etc, providing better social services for the people in the country, providing for a strong-armed police forces to maintain national & internal security and plenty more.
A deficit, as the term suggests, occurs when the spending is more than the revenue earned. When it comes to financial prudence, governments typically do not work like other entities, for instance – businesses or individuals.
While individuals, families, and businesses strive to control their spending and keep it below their earnings, a government will not work that way. Unlike the other entities, the objective of the government is NOT to have a surplus from its earnings and spending. A surplus implies either the government is taxing people more than it should OR the government is spending less than it should OR a combination of both. Spending by the government, especially in a developing economy like India, is very critical to spur overall growth and progress of the nation and its citizens, which has kept the Indian budget in deficit.
Hence, while a deficit is critical for a developing country like India, it is extremely important that it does not spiral out of control and in this regard the FRBM or Fiscal Responsibility & Budget Management bill was introduced in 2000 which became an Act in 2004.
Coming back to the deficit – as many of you would have figured out, the government has to borrow to fund this deficit. In this regard, the government works exactly like other entities. We borrow – take loans like personal loans, 2/4-wheeler loans, consumer durable loans, high-interest credit card loans, education loans, housing loans, etc. As long as we are able to pay back, loans, especially the ones which help build an asset are “good credit”.
But when people start borrowing to meet monthly expenses, it spells doom for the individual. This is “bad credit” which can lead to bankruptcy. This happens with businesses as well and we know of several large businesses that have gone bankrupt due to immense loans taken.
Now the government also borrows to fund its fiscal deficit and as mentioned earlier, a deficit under control is actually better news for the economy than no deficit.
How much does the government borrow, you ask? Well, the fiscal deficit is mentioned as a percentage of the GDP. The fiscal deficit is pegged at 3.5% for 2020 – 21. Considering India to be a US$ 2.8 tn economy, the fiscal deficit at 3.5% is roughly US $ 100 billion OR 7.1 lac crores in INR. This means the government has to borrow this amount in 1 year to fund the fiscal deficit. And needless to say, with such a huge amount of borrowing, the central government easily becomes the largest borrower in the nation.
Now comes the interesting part. With such huge borrowings, the demand for money increases, thereby leading to a rise in the price of money. The price of money being Interest Rates. High-interest rates imply less borrowing by industries to set up new factories or set up new offices, leading to a slowdown in jobs, earning power of people, ultimately leading to an overall slowdown in the economy. Now it’s very easy to understand how a high fiscal deficit indirectly influences the economic condition in a nation and ultimately its citizens.
Here is a current and ongoing example of how a (high) fiscal deficit and government borrowing makes life tough for you.
Most of you would be aware of the RBI cutting interest rates substantially over the past couple of years in an effort to boost growth. In 2019 alone the RBI cut rates by 135 bps OR 1.35%. But have your home loan rates come down in the same proportion. The answer is an overwhelming NO. Banks have failed to pass on the full benefit of rate cuts to the general public. Although there are several other reasons, high government borrowing is a major reason. And that’s how fiscal deficit indirectly impacts our lives, almost as much as Income tax rates!!! So the next year you watch the budget, do listen in keenly on the fiscal deficit part.
I hope you find this useful and if you would like to read more such stuff, I would be very happy to oblige. While I am no economist, by any stretch of the imagination, I do like to read on economics, especially personal finance, investments, financial planning, etc. Please share your suggestions on topics, terms that you would want to know more about and I will definitely try to gather information and write on those.
About the Author
Not all of us connect our daily financial lives with jargons used in government meetings and reports. Our guest author – Abhijit Paul – writes on a topic that is of great interest to him – personal finance. In fact it talks about how a completely disregarded and unknown term – fiscal deficit – affects one’s personal finance.
An experienced management professional with 12 years experience in Sales, Business Development, Ops in Banking andFinancial Services, Abhijit Paul has worked with top brands like Shuttl, Treebo Hotels, and Karvy Private Wealth.
The materials and data contained herein are for information only and shall in no event be construed as an offer to purchase or sell or the solicitation of an offer to purchase or sell any securities in any jurisdiction. Kristal Advisors does not make any representation, undertaking, warranty or guarantee as to the update, completeness, correctness, reliability or accuracy of the materials and data herein. All opinions, forecasts or estimation expressed herein are subject to change without prior notice. Kristal Advisors and its affiliates accept no liability or responsibility whatsoever for any direct or consequential loss and/or damages arising out of or in relation to any use of opinions, forecasts, materials and data contained herein or otherwise arising in connection therewith.
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