This financial year, the budget (2009-10) has a fiscal deficit of 6.8 per cent of the GDP (and this does not include the fiscal deficit of the states). The fiscal deficit will be financed mainly by market borrowings of nearly Rs.400,000 cr. There have been concerns about the high fiscal deficit. The IMF, while praising India�s ability to face the global crisis, has warned that India’s debt as a percentage of GDP was too high and, therefore, a sharp rise in the deficit could raise concerns about fiscal sustainability. The RBI governor too has underlined the need for returning to the path of fiscal consolidation to contain borrowing requirements. And the finance minister came out with the statement that the high fiscal deficit was not sustainable and in the fiscal responsibility and budget management document for 2009-10, the government plans to bring down the fiscal deficit to 5.5 per cent in 2010-11 and further to 4 per cent in 2011-12. Is the concern over the high fiscal deficit justified?
Though a large fiscal deficit by itself is not bad, it can affect the country�s economic growth adversely. A large fiscal deficit implies high government borrowing and high debt servicing (the total debt servicing will be 37 per cent of revenue expenditure in 2009-10), which in turn could mean a cut back in spending on critical sectors like health, education and infrastructure. This reduces growth in human and physical capital, both of which have a long-term impact on economic growth. Large public borrowing can also lead to crowding out of private investment, inflation and exchange rate fluctuations (impacting exports). However, if productive public investments increase and if public and private investments are complementary, then the negative impact of high public borrowings on private investments and economic growth may be offset.
How has increase in fiscal deficits impacted India�s economic growth over the years?
As public debt is normally the accumulation of liabilities created to finance the government�s budget deficit, the fiscal deficit in absolute terms should be approximately equal to the annual increase in public debt. Though this has been the case up until the year 1998-99, there seems to be a widening gap between the two thereafter (Figure 1).
Figure1: Gross Fiscal Deficit and Increase in Public Debt-Centre
Taking the annual change in public debt as a better indicator of the size of gross fiscal deficit(GFD), India�s economic growth rate has been plotted against this GFD to GDP ratio for the period 1981-82 to 2007-08. We see that the rate of growth is lower when the GFD-GDP ratio of the Central government is high. (Figure 2)
Figure 2: Fiscal Deficit-GDP Growth Rate Relationship
A simple regression shows that growth in public debt too has an adverse impact on India�s economic growth. Gross domestic capital formation is included in the regression as it is one of the most important determinants of economic growth rate.
y= 9.542 +0.095gfc -0.277pd R2=0.378
(5.75) (2.04) (-3.26)
y= growth in real Gross Domestic Product
gfc= growth in Gross Domestic Capital Formation (proxy for domestic real investment)
pd= growth in Centre�s Public Debt
The coefficient for public debt is negative and statistically significant at 1% level of significance. (Figures in brackets are the t-statistics)
Therefore, it can be said that the present disquiet in India about the rising fiscal deficit is justified. Given that high deficits have an adverse impact on India�s growth, it is imperative that the government draw up a clear roadmap to reduce fiscal deficits if it wants the economy to return to 9 per cent growth path as it says it does. What needs to be done is restructuring of public expenditure. Merely meeting targets stipulated in the FRBM Act through clever accounting practices such as the transfer of massive subsidies to oil marketing and fertiliser companies as off budget items will not do. Neither will measures like divestment to finance the fiscal deficit.