The fact that the government fiscal deficit as a percentage of GDP has come down over the last three years does not mean the absolute levels of fiscal deficits is down. In fact absolute levels of fiscal deficit has risen by 9.4% since fiscal 2013-14 even as fiscal deficit as percentage of GDP is down from 4.8% to 3.9% in fiscal 2015-16.
The reason fiscal deficit to GDP ratio trends down is that nominal GDP grows faster than fiscal deficit. Table 1 shows how fiscal deficit in absolute and relative terms has moved since fiscal 2013-14.
What happens when nominal GDP growth is less than forecast by the government? It causes a headache to the government, as relative fiscal deficit numbers will trend up if the absolute level of fiscal deficit does not come down. The government to bring down fiscal deficit for it to meet its relative target will have to either increase revenues or curtail spending.
The government for fiscal 2015-16 had taken nominal GDP growth of 11.5% for calculation of its fiscal deficit numbers. However, nominal GDP growth is placed at 8.6% as per latest estimates. The lower nominal GDP growth will increase fiscal deficit to GDP ratio if the government is not able to lower the deficit. Indications are that the absolute level of fiscal deficit will be down as the government curtails spending.
Government borrowing and the ability of the market to absorb the borrowing will be affected if fiscal deficit does not come down with lower than estimated nominal GDP growth. Table 1 and Table 2 show the fiscal deficit and government borrowing with nominal GDP growth at budgeted and revised levels respectively.
Going into fiscal 2016-17, government will peg nominal GDP growth at 11.5% as indicated by the 7th Pay Commission and if it can stick to its FRBM targets of fiscal deficit at 3.5% of GDP, then fiscal deficit and government borrowing can stay flat.
Fiscal Deficit, Revenue Deficit and Primary Deficit
Fiscal deficit is the difference between total revenues and total expenditure of the government. Given that the Indian government spends more than it earns it runs a fiscal deficit, which is financed by market borrowings. Government borrowing every year adds to the stock of outstanding debt that is at close to Rs 45 trillion. Given rising government debt, interest cost for the government rises every year (Read our note on Expenditure Budget) that in turn puts pressure on government finances, which in turn leads to fiscal deficit, which again leads to government borrowing and increase in stock of outstanding debt. A classical self-fulfilling cycle.
Fiscal deficit is the difference between total expenditure and total revenue of the government while primary deficit is fiscal deficit less interest costs. Primary deficit is expected to fall by 2.25% in 2015-16 even as fiscal deficit is expected to be marginally higher, indicating the proportion of interest payment to total expenditure.
Revenue deficit is the difference between expenditure and revenue on the revenue account. Revenue expenditure does not go into creation of capital assets and hence it is non productive. Effective revenue deficit, which was introduced in 2011-12, reduces from the revenue deficit, government grants to states and other bodies for creation of capital assets.
The government is conscious of the need to bring down levels of fiscal and revenue deficits and has adopted the FRBM (Fiscal Responsibility and Budget Management) Act that sets targets for revenue and fiscal deficit as percentage of GDP. FRBM target for 2015-16 is effective revenue deficit of 0%, revenue deficit of 2.2% and 1.6% and fiscal deficit of 3.6% and 3% respectively. Table 4.
