The government’s budget has several macroeconomic effects. This is because, the government is the largest spender of money as it carries out lot of expenditure. Government expenditure has several effects – expansion of income of the people, higher investment, stimulation of production, inflation etc. Two factors of the government’s budget decide inflationary effects of the budget – the way of financing the budget and the size of the expenditure in the budget.
Regarding the size, the central government’s budget in India has a size of nearly Rs 50 lakh crores (Rs 45 lakh crores in the 2023-24 budget). The way of financing such a big budget will have economy-wide implications. Interestingly, Rs 16 lakh crore of the Rs 39 lakh crore expenditure proposed in the 2022-23 budget is financed through borrowing. The year during the covid pandemic has higher sized borrowing in the budget.
Tax revenues are not adequate to finance the expenditure in the budget. For 2023, for example, tax revenue was only Rs 19 lakh crore out of the total Rs 39 lakh crore receipts. This means that there is a sizable gap between tax receipts and expenditure.
Financing mode of the excess expenditure (over the tax and non-tax receipts) will have decisive influence on inflation. For example, if the government finances the deficit through printing of currency (called budget deficit), it will lead to higher level of inflation. This is because the financing is done through additional money printing which adds to the existing money supply. Higher the money supply, higher will be the price level rise or inflation.
Now, if the government is resorting to borrowing (fiscal deficit), it will activate the savings of the public and there will be greater use of idle money with the people. This will also add to inflation, but not as much high as in the case of directly financing the deficit through printing of money.
In the budget, there can be six deficit types -revenue deficit, fiscal deficit, monetised fiscal deficit, budget deficit, primary deficit and effective revenue deficit. Still some of them like budget deficit and monetised fiscal deficit are not relevant in the present context. Among these three important deficits (budget deficit, fiscal deficit and monetised fiscal deficit) have inflationary relevance.
The following table shows the inflationary effect of the three types of deficits in the budget. The three deficits – Budget Deficit, Monetised Fiscal Deficit and Fiscal Deficit have direct inflationary connotations. Other deficits will have accounting importance and they don’t have explicit inflationary significance.
|Budget Deficit (BD)
|Budget deficit means printing of currency to finance the budget and hence is highly inflationary (the most inflationary deficit). This practice is not existing in India right now.
|Monetised Fiscal Deficit (MFD)
|Indicate borrowings by the Government from the RBI to run the budget. Such borrowings create inflation because of the use of newly printed currency. When the money is paid back to the RBI, the inflation effect may be reduced. Still, MFD is less inflationary compared to BD as the money is paid back by the RBI. If the money is not paid back to the RBI, it will be as inflationary as the BD. The monetized fiscal deficit is not there in India at present.
|Fiscal Deficit (FD)
|Shows borrowings of the Government to finance the budgetary expenditure. The FD is not financed through newly printed currency. Still, the borrowing is financed from the money provided by the largely rich people who keeps their money unspent. The inactive money of the rich is made active through borrowing and is used to finance expenditure. In this context, fiscal deficit adds to inflation. The inflationary effect of FD will be lower than BD and MFD.
|Revenue deficit (RD)
|Implies that day to day government receipts are not enough to finance the day to day government expenditure. Here, there are rising current expenditures. To finance the revenue deficit, the Government should have a capital surplus (through borrowings). Higher RD will reduce the quality of government spending and will increase the debt burden of the Government indirectly. Higher Revenue Deficit will also cause higher level of inflation. But what is important is the way of financing of RD. Hence, the inflationary effects of RD can not be directly assessed.
|Primary Deficit (PD)
|Shows the amount of government borrowing that is used to finance expenditure over and above interest payments. Here, PD means the amount of non-interest expenditure financed through borrowing o. Lower PD is desirable as it reflects less financing of other expenditures (other than interest payments) using borrowed money. Do not misunderstand that borrowing should be used to finance interest payments. Rather if the Government continuously uses borrowings to finance other expenditures as well, the future debt burden will go up. It is in this sense that higher PD is increasingly undesirable. Higher PD may cause higher inflation, depending upon the nature of financing.
|Effective Revenue Deficit
|Effective revenue deficit is obtained by reducing grants for the creation of capital assets from revenue deficit. Or in other words, it is that revenue deficit obtained after deducting the productive asset making expenditure from revenue deficit. It shows that some of the RD are productive. ERD has no direct connection with inflation.