India’s fiscal balancing amid global economic uncertainties

However, such measures could strain trade ties and inflate prices, potentially exacerbating the fiscal burden in the long term. This concern becomes important when explored in the context of what the fiscal deficit means. 

What is fiscal deficit?

The fiscal deficit occurs when the government’s total expenditure exceeds its total revenue (excluding borrowings) in a given financial year. In other words, the fiscal deficit is reflective of the total borrowing requirements of the government.

A broader understanding of the deficit is the difference between the size of the government debt at the beginning of the financial year and the final size of the debt at the end of the year. A continuously increasing ratio of debt to GDP runs the risk of fiscal stress, potentially pushing the country towards an unsustainable debt path and leading to national insolvency.

It can be understood through the formula of fiscal deficit as well: 

Fiscal Deficit = Total Government Expenditure – Total Government Revenue (Excluding borrowings in a given financial year)

Government expenditure or spending includes salaries, pensions, infrastructure projects, healthcare, and interest payments on past borrowings. 

Sources of government revenue (excluding borrowings) can be divided into two categories: 

Types of deficit

Apart from fiscal deficit, the Union Budget factors in various other types of deficit including: 

— Revenue deficit: This occurs when revenue expenditure exceeds revenue receipt.

— Primary deficit: This is calculated as fiscal deficit minus the interest payments on previous borrowings. The primary deficit is the government’s non-interest outlays minus total revenues.

The total or standard deficit can be written as:

G + (i × Debt) – T

(G = Government’s non-interest outlays; T = Total revenue (tax and non-tax); i = Interest rate on the government debt; Debt = Outstanding government debt)

The primary deficit is then G – T. 

With this notation, it can be shown that the change in the ratio of debt to GDP can be written as: 

Debt-to-GDP Ratio = Government Debt/GDP​

Thus, a budget deficit implies that the national debt is increasing. However, the rise or fall of the debt-to-GDP ratio depends on the relative pace of debt accumulation versus economic growth. If GDP grows faster than debt, the ratio may decline. If debt grows faster, the ratio worsens and raises sustainability concerns.

The fiscal deficit is thus the difference between the government’s total spending and the revenue collected. While this gap is important to stimulate growth, it raises concerns about long-term fiscal sustainability. This brings the focus on the broader concept of budget deficit.

Budget deficit

The concept of budget deficits is often popular because it allows for higher levels of government spending and lower levels of taxation. However, deficits shift the fiscal cost to future generations, who are not yet voters. While the very tangible benefits of deficit spending – such as lower taxes and more public services – are immediately visible, burdens that deficits impose on the economy are often hidden and deferred. 

The fiscal deficit is computed both in absolute terms and as a percentage of the country’s GDP. By using the term deficit, it may sound like a negative indicator. But moderate levels of fiscal deficit are considered a positive sign for the economy. In fact, they are seen as indicators of productive government spending on schemes and infrastructure projects that may boost growth in the future. 

In essence:

— A high deficit isn’t always bad if funds are used for long-term development, and

— Balancing the deficit ensures stability while enabling progress.

To understand the impact of fiscal deficit, it’s necessary to look at how the government finances it and where it spends.

Management of fiscal deficit 

In order to fund its fiscal deficit, the government mainly borrows money from the bond market, where investors compete to purchase government-issued bonds. As the government’s finances worsen, demand for these bonds begins to drop, forcing the government to pay higher interest rates to lenders – this leads to higher borrowing costs for the government.

But this is not true for India as the country’s economy is continuing on the path of fiscal consolidation, with efforts to lower debt and maintain prudent fiscal management.

The government intends to bring the fiscal deficit below 4.5% of GDP by 2025-26. Managing the fiscal deficit is important as:

— Excessive debt can fuel inflation, and

— A lower but not completely zero deficit reflects sound economics.

This emphasis on balanced fiscal discipline was reiterated by Finance Minister Nirmala Sitharaman while presenting the Union Budget 2025.

In 2024-25, the centre is expected to borrow a gross amount of Rs 14.13 lakh crore from the market, which is lower than its borrowing goal for 2023-24. This reduction is attributed to expected higher GST collections, which would help fund expenditure. But the question arises – where does the Government spend the excess of expenditure over revenue? 

The government employs deficit financing to stimulate: 

— Economic growth 

— Support social welfare programs  

— Address emergencies

Such targeted spending would lead to stimulation of growth in the economy. Importantly, if the spending is within the acceptable deficit range, it supports the broader goals to have low debt and be fiscally disciplined.

Why fiscal discipline matters 

A high fiscal deficit can mean inefficient spending by the government, which can contribute to inflationary pressure in the economy. A high fiscal deficit forces the government to borrow more from the market, which boosts the demand for credit and can potentially lead to higher interest rates. 

Higher interest rates, in turn, raise businesses’ costs of borrowing, hindering their investments and slowing overall economic growth. Moreover, higher debt can restrict a government’s budget in the long run, and various growth related schemes would be adversely affected. Hence, it is  essential for governments to be watchful and vigilant about their fiscal deficits.

Post Read Questions

What is fiscal deficit and how does it reflect the government’s financial health?

Why is it important for the government to maintain a moderate, but not zero, fiscal deficit?

What steps has the Indian government taken under Budget 2025 to move toward the fiscal deficit target of below 4.5% by 2025–26?

In what ways can deficit financing contribute positively to economic growth and welfare?

Is India’s current fiscal deficit strategy sustainable in the face of potential economic shocks or global slowdowns?

(Meera Malhan and Aruna Rao are Professors in economics at Delhi University.)

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