Fiscal Deficit: Meaning, Components, Formula, Fiscal Deficit UPSC

By BYJU'S Exam Prep

Updated on: November 14th, 2023

Fiscal Deficit can be defined as the difference between the total revenue and expenditure of the government. So in simple words, we can understand that the Fiscal Deficit figure is the amount that the government needs to meet its expenditure. Therefore, if the Fiscal Deficit is bigger then the government needs to get the borrowings to meet the extra expenses which are out of running the government.

Fiscal deficit is the difference between a government’s total expenditure and its total revenue, excluding borrowing. It is an important topic for the UPSC exam as it relates to public finance and economic management. The topic comes under the Indian Economy section of the UPSC syllabus.  Understanding fiscal deficit is crucial for a comprehensive understanding of public finance and economic policies.

Fiscal Deficit

Fiscal Deficit is a crucial concept in public finance that measures the gap between a government’s total expenditure and its total receipts, excluding borrowing. It is the result of various factors, including a significant increase in capital expenditure and a deficit arising from revenue. By examining fiscal deficit, policymakers can assess how effectively the government is managing its finances and whether it is spending more than it is earning.

Understanding the Fiscal Deficit is essential as it reflects the overall financial health of a government and its ability to meet its expenditure commitments. A high fiscal deficit indicates that the government is heavily reliant on borrowing to cover its expenses, which can have long-term implications on the economy. It can lead to increased debt burden, inflationary pressures, and constraints on investment and growth.

Fiscal Deficit Meaning

The Consolidated Fund of India’s fiscal deficit is defined by the government as “the excess of total disbursements from the Fund, except repayment of the debt, over total revenues into the Fund, excluding debt receipts, during a financial year.”

The total amount of money spent in excess of income, or fiscal deficit, is measured as a percentage of gross domestic product (GDP). By marking out the difference between the total income and the total expenditure by the government, the Fiscal Deficit is calculated.

Fiscal Deficit Formula

Fiscal deficit is calculated using a specific formula that helps measure the financial gap between a government’s total expenditure and its total receipts, excluding borrowings. This formula provides a quantitative measure of the fiscal health of a country. The fiscal deficit formula is as follows:

Fiscal Deficit = (Revenue Expenditure + Capital Expenditure) – (Revenue Receipts + Capital Receipts)

The formula reads out in the simplified form as:

Fiscal Deficit = Total expenditure — Total receipts excluding borrowings

In this formula, the total expenditure refers to all the expenses incurred by the government, including both revenue and capital expenditure. Total receipts, on the other hand, include all sources of government revenue, such as taxes, fees, and other income, excluding borrowings. By subtracting total receipts from total expenditure, we can determine the fiscal deficit, which indicates the extent to which the government’s expenses exceed its non-borrowed revenue.

Components of Fiscal Deficit

Fiscal Deficit is composed of two main components, namely the Revenue Component and the Expenditure Component. These components play a crucial role in determining the overall fiscal health of a government. Following are the Components of Fiscal Deficit:

  • Revenue Component: This component includes the revenue collected from taxes imposed by the central government, such as corporation tax, customs duties, excise duties, GST, and other tax-related income. It also includes taxable income from sources like interest receipts, grants in aid, dividends, and receipts from Union Territories.
  • Expenditure Component: The expenditure component represents the funds allocated by the government for various purposes, including pension payments, salaries, infrastructure development, healthcare, and other areas outlined in the budget. It reflects the government’s spending patterns and priorities.

Framework of Fiscal Deficit

Understanding the framework of fiscal deficit provides insights into the processes and policies that shape fiscal management of India. The framework of Fiscal Deficit in India is influenced by several factors and policies aimed at ensuring responsible financial management. Following are the key points regarding the framework of Fiscal Deficit:

  • Finance Commission: The Indian constitution mandates the establishment of a Finance Commission every five years to guide the allocation of federal funds to state governments and provide medium-term fiscal guidance.
  • Union Budget: The government presents the Union Budget to the Parliament, which outlines the proposed taxing and spending provisions. The Parliament’s adoption of these provisions plays a vital role in shaping fiscal policy.
  • FRBM Act: In an effort to address fiscal restraint, the Fiscal Responsibility and Budget Management (FRBM) Act of 2003 was enacted. This act aims to maintain fiscal discipline, reduce fiscal deficits, and promote long-term fiscal sustainability.

Deficit Financing

Deficit Financing is the process by which the government spends more money than it collects in taxes and makes up the shortfall by borrowing money or creating new money. When the government’s overall income (revenue account plus capital account) is less than its total expenditures, deficit financing may result.

The government may choose to borrow money from the public by issuing bonds and other securities, ordering the Reserve Bank of India to create fresh currency notes, or withdrawing funds from its cash balance deposited with the RBI. Printing extra money or issuing bonds are a couple of examples of Deficit Financing.

Advantages and Disadvantages of Deficit Financing

Deficit financing refers to the practice of a government borrowing money to cover its expenditure when its revenue falls short. Check the Advantage and Disadvantage of Deficit Financing in detail below.

Advantages of Deficit Financing:

  • Economic Stimulus: Deficit financing can be used as an economic tool to stimulate demand and boost economic growth. By injecting additional funds into the economy, it can lead to increased consumption, investment, and employment.
  • Infrastructure Development: Deficit financing can help finance crucial infrastructure projects that contribute to long-term economic development. It allows governments to invest in sectors such as transportation, energy, and healthcare, which can enhance productivity and attract private investments.
  • Social Welfare Programs: Deficit financing can support social welfare programs, such as education, healthcare, and poverty alleviation, by providing the necessary funds. These programs can have a positive impact on society by improving living standards and reducing income disparities.

Disadvantages of Deficit Financing:

  • Increased Debt Burden: Deficit financing leads to increased borrowing, which can result in a higher debt burden for the government. High levels of debt can strain public finances, increase interest payments, and limit the government’s ability to invest in other areas or respond to economic downturns.
  • Inflationary Pressures: When deficit financing is not accompanied by corresponding increases in productivity or output, it can lead to inflationary pressures. The increased money supply without a proportional increase in goods and services can drive up prices and reduce the purchasing power of individuals.
  • Dependency on External Financing: If a government relies heavily on external sources to finance its deficit, it can create vulnerabilities. Fluctuations in international financial markets or changes in interest rates may affect borrowing costs and create risks for the economy.

Fiscal Deficit 2023

In the Union Budget 2023, India’s fiscal deficit for the year 2023-24 is estimated to be 17.86 trillion rupees. This represents a significant portion of the country’s budget, with the fiscal deficit projected to be around 5.9% of the GDP in the same year.

To address the issue of fiscal consolidation, the government aims to reduce the fiscal deficit to less than 4.5% of the GDP by the year 2025-2026. The Finance Minister has set this target as part of the government’s commitment to maintaining fiscal discipline and sustainable economic growth.

Additionally, the 15th Finance Commission, chaired by NK Singh, has recommended that the central government further reduce its fiscal deficit to 4% of the GDP by 2025-2026. This recommendation is in line with the goal of reducing outstanding liabilities to 56.6% of the GDP.

Reasons for High Fiscal Deficit

A high budget deficit may benefit the economy if the funds are used to build transportation infrastructure, such as roads, ports, and airports, which promotes economic expansion and leads to job creation. There are mainly two reasons for the high Fiscal Deficit, firstly, either less revenue realization like during the pandemic due to the closing of businesses and other commercial activities, or the revenue collection has dipped lowest. The second reason is increasing expenditure by the government, due to the government’s obligation towards many schemes like- health, education, etc.

The expenditure is high, and the obligation increases further during the pandemic when the government has taken various steps like providing free food, vaccination, and direct benefit transfer (DBT), among others, which further increases the burden on the finances resulting in further increasing Fiscal Deficit.

Fiscal Deficit UPSC

Fiscal deficit refers to the gap between the total amount of money that the government spends and the total amount of money it receives, excluding any borrowed funds. Fiscal Deficit is an important topic for economics which comes under the General Studies Paper 3 Syllabus. Fiscal Deficit and Deficit financing are important topics of the economy which are recently been seen in the news.

To prepare for the topic of Fiscal Deficit, students can also refer to the Economics Books for UPSC. Candidates preparing for the UPSC exam should have a clear understanding of fiscal deficit and its implications on the economy. They should analyze the impact of fiscal deficit on economic indicators, fiscal policies, and the overall financial stability of the country.

Fiscal Deficit UPSC Questions

Question: Consider the following statements: (1) Market borrowing, (2) Treasury bills, (3) Special securities issued to RBI

Which of these is/are components of internal debt? (A) 1 only, (B) 1 and 2, (C) 2 only, (D) 1, 2 and 3

Answer: (D) 1, 2 and 3

Question: Which of the following is not a part of India’s National Debt? (A) National Savings Certificates, (B) Dated Government Securities, (C) Provident Funds, (D) Life Insurance Policies

Answer: (A) National Savings Certificates

For UPSC Mains

Question: Discuss the causes and consequences of a high fiscal deficit in the economy. How does it affect the overall macroeconomic stability and long-term growth prospects of a country?

Question: Analyze the measures that can be taken to reduce fiscal deficit without compromising on essential government expenditures. How can fiscal consolidation be achieved while ensuring sustainable economic development and social welfare?

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