The Hindu Business Line : Defining deficits

By now, you sure will know that the nation’s budget involves presentation of revenues and expenses, similar to your household budget. Suppose you bought a bike this month or repaired your house or loaned money to your friend or simply splurged on clothes and accessories, your expenses (outgo) may exceed your salary (the principal source of revenue), is it not? Ditto with the country’s budget.

When the expenditure from the Consolidated Fund exceeds the income, there arises a shortfall. This, in budgetary parlance is called ‘deficit’.

Not one, but many

But what may fox you is the number of deficits the Finance Minister and other experts talk about. While in a public meeting, he speaks of controlling the ‘fiscal deficit’, he talks of achieving the target set for ‘revenue deficit’ in a TV show. Further, a careful reading of the budget documents will bring to light one more — a primary deficit.

Before you make sense of these deficits, know that law requires the budget to distinguish between income and expenses of revenue and of capital nature.

All receipts and expenses that are recurring and do not involve creation of an asset are revenue in nature. Income from the levy of taxes, expenses in the form of salaries are the main items that fall under the revenue head.

Others like loans obtained by the government, infrastructure investments are items that fall under the capital head.

Understanding this is primary to understanding a deficit because, the deficit may arise either in the revenue budget or in the capital budget.

Revenue Deficit

A revenue deficit arises when the income in the revenue account is not enough to cover all the revenue expenses.

To make good the shortfall, the government resorts to borrowing. But borrowing money to meet operating expenses is unproductive as it does not help in capital formation. Take the example of a street vendor. If he borrows money to purchase goods for his trade, he will earn some money out of it and can use it to repay the loan as well as the interest.

But if he borrows money for his day-to-day expenses, deployment of that money will not bring in any benefits. In fact, he will resort to more borrowing to pay the interest and repay the principal, eventually falling into a debt trap.

So, ideally, the revenue deficit in a budget should be zero. The government, through the FRBM (Fiscal Responsibility and Budget Management) Act is aiming at reducing revenue deficit to zero by 2008-09.

Fiscal Deficit

While a revenue deficit is the difference between revenue expenditure and revenue income, fiscal deficit is the difference between the total (revenue and capital) expenditure and the total receipts, excluding borrowings.

One method to combat fiscal deficit is to borrow from the RBI. Called ‘deficit financing’, this involves increasing the currency circulation by printing more money. But in times of high fiscal deficit, printing money may lead to high inflation in the economy, as ‘too much money will chase too few goods’.

Another option is to resort to bank borrowing. The best method to reduce fiscal deficit (the FRBM Act aims at reducing fiscal deficit to 3 per cent by 2008-09), however, is to increase revenues and reduce expenditure. But in India, it has been characterised more by reduction in capital expenditure. This practice eventually has a negative impact on economic growth.

Primary Deficit

The primary deficit equals all receipts minus all expenses other than net interest. Interest receipts and payments may arise from loans availed of/given in the past years.

By excluding interest, the primary deficit provides a more direct measure of overall government spending and taxing for a given fiscal year. It is also calculated as fiscal deficit minus interest payments.

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