India’s fiscal deficit, which maps how much money the government has to borrow to make up the gap between its expenditure and revenue, was just 3.4 per cent of the gross domestic product (GDP) for 2018-19. For the current year, the Union Budget expected the fiscal deficit to be 3.3 per cent of the GDP. However, former Economic Affairs secretary S.C. Garg recently claimed that the true fiscal deficit for 2018-19 is 4.7 per cent - more than a full percentage point than the official claim.

What is the fiscal deficit?

The fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing). In layman’s terms, it corresponds to the borrowings and liabilities of the government. As per the technical definition, fiscal deficit is equal to budgetary deficit plus borrowings and other liabilities of the government.

What is its significance?

* In the economy, there is a narrow pool of investible savings. These savings are used by financial institutions like banks to lend to private businesses and governments.

* The significance of fiscal deficit is that if this ratio is too high, it hints that there is a lesser amount of money left in the market for private entrepreneurs and businesses to borrow.

* Lesser amount of this money, in turn, leads to higher rates of interest charged on such lending. So, a higher fiscal deficit means higher borrowing by the government, which, in turn, means higher interest rates in the economy.

* This becomes even more important when, like today, Indian businesses are facing high interest rates. A huge fiscal deficit and higher interest rates at a time like this would also mean that the efforts of the Reserve Bank of India to reduce interest rates are incomplete.

What is an acceptable level?

* There is no set global level of fiscal deficit that is considered good. Typically, for a developing economy, where private enterprises may be weak and governments may be in a better state to invest, fiscal deficit could be higher than in a developed economy.

* In developing economies, governments also have to invest in both social and physical infrastructure upfront without having adequate avenues for raising revenues.

* In India, the Fiscal Responsibility and Budget Management Act requires the central government to reduce its fiscal deficit to 3 per cent of the GDP. But India has been struggling to achieve this mark.

What is the FRBM Act?

* The Fiscal Responsibility and Budget Management Act is a fiscal sector legislation enacted in 2003. It wanted to ensure fiscal discipline for the Centre by setting targets, including reduction of fiscal deficits and elimination of revenue deficit. It is a legal step to ensure fiscal discipline and consolidation.

* The FRBM Act attempted to fix responsibility on the government to strengthen the framework for adopting a prudent fiscal policy. It paves the way for accomplishing macroeconomic stability.

Major provisions of the Act

* The FRBM Act set a target reduction of fiscal deficit to 3 per cent of the GDP by 2008-09. This will be realised with an annual reduction target of 0.3 per cent of the GDP per year by the central government.

* Revenue deficit has to be reduced by 0.5 per cent of the GDP per year with complete elimination by 2008-09.

* Reduction of public debt.

* The government has to take appropriate measures to reduce the fiscal deficit and revenue deficit so as to eliminate revenue deficit by 2008-09 and thereafter, sizable revenue surplus has to be created.

* It mandated setting annual targets for reduction of fiscal deficit and revenue deficit, contingent liabilities and total liabilities.

* The government shall end its borrowing from the RBI except for temporary advances.

* The RBI was supposed to not subscribe to the primary issues of the central government securities after 2006.

* The revenue deficit and fiscal deficit may exceed the targets specified in the rules only on grounds of national security, calamity and other exceptional grounds to be specified by the central government.

Major objectives of the Act

* Reduction of fiscal deficit and revenue deficit.

* To achieve inter-generational equity in fiscal management by reducing the debt burden of the future generation.

* Achieving long-term macroeconomic stability.

* Better coordination between fiscal and monetary policy.

* Transparency in fiscal operations of the government.

Implementation of the Act

There was an improvement in the fiscal performance of both the Centre and states because of the implementation of the FRBM Act. The states achieved the targets much ahead of the prescribed timeline. The central government was also on the right path of achieving this objective. However, due to the global financial crisis, this was suspended. Consequently, the fiscal consolidation as mandated in the FRBM Act was put on hold in 2007-08. The crisis period called for increased level of expenditure by the government to boost demand in the economy. As a result of fiscal stimulus, the government has moved away from the path of fiscal consolidation.

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