INTRODUCTION
A fiscal deficit happens when a government's expenses are
more than its earnings from taxes and other sources. In
simple terms, it means the government is spending more
money than it is making. To cover this gap, the government
usually borrows money by taking loans or issuing bonds.
A small fiscal deficit can be normal, especially if the money is
used for development projects, but a large and long-term
deficit can lead to financial problems like rising debt and
inflation.
The fiscal deficit is a crucial indicator of a country's financial
health, representing the shortfall between government
revenue and expenditure. It affects inflation, GDP growth,
government borrowing, and economic stability. This project
analyzes India's fiscal deficit trends, assesses its impact on
inflation and GDP, and evaluates government strategies to
manage it.
Why Does Fiscal Deficit Happen?
Fiscal deficit happens when:-
The government spends more on public services, infrastructure,
and welfare schemes.
Tax collection and other revenue sources are not enough to
meet expenses.
Unexpected events like economic slowdowns, wars, or pandemics
increase spending.
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OBJECTIVES
Economic Growth and Social Welfare and
Development Public Services
Boosting Demand During
Economic Slowdowns
Supporting Key
Reducing Income
Industries and
Inequality
Employment
1. Economic Growth and Development
The government borrows money to invest in roads, railways, schools, hospitals, and
other infrastructure that improve people’s lives.
These investments create jobs and boost economic activity, leading to higher
incomes and a better standard of living.
A controlled fiscal deficit helps developing countries grow faster.
2. Social Welfare and Public Services
Many governments spend money on education, healthcare, pensions, and subsidies
for the poor.
If government revenue is not enough, a fiscal deficit allows continued funding for
these essential services.
This ensures that everyone gets access to basic needs, even during tough economic
times.
3. Boosting Demand During Economic Slowdowns
In times of economic crisis (like recessions), businesses slow down, and people lose
jobs.
To stimulate the economy, the government increases spending on projects and
provides financial support to industries and workers.
This extra spending helps increase demand, encourage production, and bring the
economy back on track.
4. Reducing Income Inequality
Fiscal deficit allows the government to spend on welfare programs, helping lower-
income groups.
Subsidies, free healthcare, and financial aid to farmers or small businesses help
bridge the wealth gap.
5. Supporting Key Industries and Employment
Sometimes, important industries (like agriculture, energy, or manufacturing)
struggle due to economic conditions.
The government may provide subsidies, tax cuts, or direct financial help to keep
these industries running.
This helps protect jobs and prevent major economic downturns.
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Understanding Fiscal Deficit
Fiscal Deficit = Total Expenditure - Total Revenue (excluding
borrowings)
A high fiscal deficit suggests excessive spending, while a lower
deficit indicates fiscal discipline.
If a government spends $100 billion but earns only $80 billion from taxes
and other sources, the fiscal deficit is $20 billion.
Why Does Fiscal Deficit Happen?
A fiscal deficit happens when the government spends more money than it
earns from taxes and other sources. There are several reasons why this can
occur, which can be broadly classified into economic, social, and policy-
related factors.
1 High Government Spending on Development
Governments spend large amounts on infrastructure projects such as:
Roads, highways, and bridges
Railways, airports, and public transport
Schools, universities, and hospitals
Power plants and water supply
These projects require a huge budget, and if tax revenues are not enough
to cover these costs, the government borrows money, increasing the fiscal
deficit.
Example: A developing country may invest heavily in infrastructure to boost
economic growth, leading to a temporary fiscal deficit.
2. Social Welfare Programs
Governments provide various welfare programs to support citizens, such as:
Free or subsidized education and healthcare
Food subsidies for low-income families
Unemployment benefits and pensions
Housing schemes for the poor
While these programs help people, they increase government expenses. If
tax revenue is low, the government has to borrow money, increasing the
fiscal deficit.
Example: India runs large food subsidy programs to help poor families, which
adds to the fiscal deficit.
3. Economic Crisis and Recession
During economic downturns or recessions:
Businesses earn less profit, so they pay lower taxes.
People lose jobs, reducing income tax collections.
The government spends more on unemployment benefits and financial aid.
This combination of lower income and higher spending leads to a fiscal deficit.
Example: During the COVID-19 pandemic, many governments borrowed heavily
to provide financial support to businesses and citizens, increasing their fiscal
deficits.
4. Low Tax Revenue Collection
Sometimes, the government is unable to collect enough revenue due to:
Tax evasion – People or businesses do not pay full taxes.
Economic slowdown – Fewer businesses and jobs mean lower tax collection.
Tax cuts – The government reduces taxes to boost the economy, but this
lowers revenue.
When tax collection is low, the government cannot meet its expenses, leading
to a fiscal deficit.
Example: In 2017, the U.S. reduced corporate tax rates, which lowered
government revenue and increased the fiscal deficit.
5. Rising Debt and Interest Payments
Governments borrow money by issuing bonds and taking loans.
However, these loans must be repaid with interest. If the debt is
large, a significant part of the government's budget goes towards
paying interest, increasing expenses.
If the government does not have enough income, it may need to
borrow more money just to pay interest, which increases the fiscal
deficit.
Example: Countries like Japan and the U.S. have large national
debts, leading to high interest payments and continuous fiscal
deficits.
6. Political and Policy Decisions
Governments sometimes intentionally run a fiscal deficit to:
Win public support by increasing spending on welfare programs.
Boost the economy by spending on infrastructure and industries.
Provide subsidies to farmers, businesses, or industries.
If such policies increase spending without increasing revenue, the
fiscal deficit rises.
Example: Before elections, governments often increase spending on
social schemes, which can lead to higher deficits.
4. Trends in India’s Fiscal Deficit (2017-2023)
Recent Trends (2019-2025):
2019-2020: The fiscal deficit stood at 7.69% of GDP in 2019, increasing
to 12.86% in 2020 due to pandemic-related expenditures.
2021-2022: A gradual reduction was observed, with the deficit at 9.27%
in 2021 and 9.20% in 2022.
2023-2024: The deficit further narrowed to 5.63% of GDP in 2023-
2024, below the full-year target of 5.8%. Trading Economics
2024-2025: For the fiscal year 2024-2025, the government aims to
reduce the fiscal deficit to 4.4% of GDP.
Government
. Initiatives:
To achieve fiscal consolidation, the Indian government has focused on:
Enhancing Revenue: Implementing tax reforms to increase collections.
Rationalizing Expenditure: Prioritizing spending on infrastructure and
social sectors while reducing non-essential expenditures.
Disinvestment: Selling stakes in public sector enterprises to raise funds.
Relationship Between Fiscal Deficit, Inflation, and GDP
The relationship between fiscal deficit, inflation, and GDP (Gross Domestic
Product) is complex, as these factors influence each other in various ways. Let's
break it down:
1.Fiscal Deficit and GDP
Fiscal Deficit Definition:
A fiscal deficit occurs when a government's total expenditure exceeds its total
revenue (excluding borrowings). The government borrows to cover the gap.
Relationship with GDP:
Government Borrowing and Economic Activity: When a government runs a fiscal
deficit, it may borrow money to finance its spending. This spending can stimulate
economic activity, particularly if it is directed toward infrastructure, welfare
programs, or investment.
Short-Term Economic Growth: In the short term, increased government
spending (even if borrowed) can boost aggregate demand, contributing to higher
GDP growth.
Long-Term Impact: However, if the fiscal deficit is persistent and large, it may
lead to concerns about debt sustainability and may affect long-term growth
prospects. High levels of borrowing can reduce private sector investment because
the government competes for funds in financial markets.
Fiscal Deficit (% Govt Borrowing (₹ Inflation Rate
Year GDP Growth (%)
of GDP) Lakh Cr) (%)
2017-18 3.5 6.37 3.6 7
2018-19 3.4 6.22 3.4 6.1
2019-20 4.6 7.73 4.8 4.2
2020-21 9.5 14.94 6.6 -7.3
2021-22 6.9 12.14 5.1 8.7
2022-23 6.4 8.4 5.7 7
Example: A government increases spending on infrastructure, which increases
GDP in the short term. But, if the deficit grows too large, it may lead to
higher borrowing costs in the future, possibly dampening economic growth.
2. Fiscal Deficit and Inflation
Fiscal Deficit and Demand-Pull Inflation:
A high fiscal deficit often means that the government is spending more
than it earns. If this spending is financed by printing money (monetary
expansion), it can lead to an increase in the money supply, causing
demand-pull inflation.
If the government borrows heavily from domestic banks or foreign
investors, it can create inflationary pressures as demand for goods and
services increases while production may not keep pace with the rising
demand.
Fiscal Deficit and Cost-Push Inflation:
If the government borrows too much, it may raise interest rates (to
attract more investors for government bonds). Higher interest rates can
increase the cost of borrowing for businesses, which might pass on
these costs to consumers in the form of higher prices.
services, pushing prices up, causing inflation.
Fiscal Deficit (% Inflation Rate
Year
of GDP) (%)
2017-18 3.5 3.6
2018-19 3.4 3.4
2019-20 4.6 4.8
2020-21 9.5 6.6
2021-22 6.9 5.1
2022-23 6.4 5.7
Government Spending and Inflation:
Increased government spending, especially when demand exceeds supply,
can result in higher inflation if the economy is already operating near
full capacity.
Example: If the government spends excessively on social welfare
programs without raising taxes, it can increase demand for goods and
services, pushing prices up, causing inflation.
3. Fiscal Deficit, Inflation, and Govt borrowing
These three factors—fiscal deficit, inflation, and GDP—are connected and
can influence each other in both positive and negative ways:
Short-Term Economic Growth vs. Inflation:
Increased government spending (leading to a fiscal deficit) can boost GDP in
the short term by stimulating demand.
However, if the deficit is high and persistent, it can lead to inflation as demand
exceeds supply, especially if the economy is already close to full capacity.
Higher inflation may erode real purchasing power, affecting consumers'
spending habits and possibly reducing GDP growth in the long term.
Debt Sustainability and Long-Term Growth:
If the government continues to run large fiscal deficits, it may face higher
interest payments in the future, which could reduce public sector
investment in productive areas like infrastructure, education, or healthcare.
High inflation can also undermine long-term economic growth by creating
uncertainty in the economy and reducing consumer confidence and
investment.
Conclusion
A fiscal deficit is a critical indicator of a government's financial
health, representing the gap between its total expenditures and
total revenues (excluding borrowings). While a certain level of fiscal
deficit is necessary for economic growth, particularly in developing
economies, excessive deficits can have negative consequences on
long-term economic stability.
In the short term, fiscal deficits can stimulate growth by increasing
government spending on infrastructure, welfare programs, and
other essential sectors. This, in turn, can boost aggregate demand,
create jobs, and potentially enhance GDP growth. However, if a
government consistently runs large fiscal deficits without
corresponding revenue growth, it can lead to rising public debt and
inflationary pressures, which may undermine the long-term
economic health of the country.
The challenge for governments is to strike a balance between
stimulating growth through fiscal spending and maintaining debt
sustainability and price stability. Careful fiscal consolidation,
through measures such as enhancing revenue, rationalizing
expenditure, and disinvestment, is necessary to ensure that fiscal
deficits remain manageable and do not lead to an unsustainable
debt burden.
Ultimately, a well-managed fiscal deficit is an essential tool for
economic development, but it must be accompanied by prudent
fiscal policies that focus on growth without compromising the
country's fiscal future.
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INDEX
Introduction
Objectives
Understanding Fiscal Deficit
Trends in India’s Fiscal Deficit
Relationship Between Fiscal
Deficit, Inflation, and GDP
conclusion
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