In a developing economy like ours, the government shall do the job of an active entrepreneur in directing the process of development. There are lot of expenditure commitments for the government in a growing economy. It has to create infrastructure, provide social expenditure and has to accelerate the process of industrialisation. Side by side, the government shall initiate poverty eradication and employment generation measures to facilitate equality (government as an active economic agent and a facilitator). For all these, high level of government expenditure is needed in the context of lack of money to finance such expenditure.
Similarly, when the economic growth is low due to inadequate private expenditure, the government has to spend more. This is possible only by increasing public expenditure using borrowing. Similarly, it has to promote private expenditure by reducing taxes. The last global financial crisis has made resurgence in the use of fiscal policy to escape from a macroeconomic crisis. All these will raise government’s borrowing which is termed as fiscal deficit in the Indian context. In its practical sense, fiscal deficit is borrowing to run the budget.
On the other side, some countries like Greece and Spain faced crisis because of depending on high level of public debt (fiscal deficit). Fiscal policy should be cautiously and judiciously applied. Otherwise, it will create bad outcomes like a debt crisis. Though fiscal deficit is desirable, the cost for adopting it as a budget practice is also significant in the Indian context:
- The fiscal deficit in India has low degree of monetisation because of the absence of both budget deficit and monetisation of fiscal deficit. But still it creates inflation because of the demand impact of high level of expenditure by the government.
- Fiscal deficit is met through borrowing by the government from the open market at competitive rate of interest, which increases the overall interest rate in the economy.
- Crowding out effect: high level of public borrowings reduces the opportunity of the private sector to borrow and finance their investments.
- Future interest payment burden for the government increases. Hence it adds to the burden on the future generation. Here, the expenditure is made for the current generation but debt is paid back by the future generation. Hence Fiscal Deficit violates the principle of intergenerational equity.
Inevitably, there is a break-even point, where the benefit from government expenditure is equal to the costs of fiscal deficit-inflation, crowding out, debt burden, inefficient resource allocation etc. High level of fiscal deficit is undesirable and may bring negative effects. Excess government expenditure today and the consequent debt will erode intergenerational equity. At the same time, every economic environment necessitates a substantial degree of government expenditure with deficit financing. Rightsizing of fiscal deficit is the major task of the government.
The FRBM Review Commitee under NK Singh recommended strong fiscal consolidation steps. According to the Commitee, government has to stick on to the 3% fiscal deficit target. Government can have a flexibility of changing FRBM target by 0.5% during inevitable circumstances.