Fiscal deficit refers to the gap between the government expenditure and revenue, excluding borrowing.
- Fiscal deficit = total expenditure – total government revenue.
- Or, Fiscal deficit = Total Government Expenditure – (Tax Revenue + Non-tax Revenue)
Fiscal deficit is common irrespective of the nature and development status of the economy. Both developed and underdeveloped countries generally create fiscal deficits intentionally.
As the need for government expenditure expands and governments have limited resources, fiscal deficits are common globally.
Regarding the rationale for fiscal deficits, the classical school of thought opposes creating fiscal deficits and favours a small, balanced budget.
According to them, fiscal deficit creates a crowding-out effect in the economy, eroding efficiency and competitiveness. So, the fiscal deficit is undesirable to the classical economist.
But for Keynes, a fiscal deficit is a good choice for the government because the government expenditure multiplier is greater than 1.
And so, if the government increases spending by borrowing, it supports growth and employment in the economy. So, the Keynesians suggest creating a fiscal deficit, but within limits.
Irrespective of the different theoretical arguments, fiscal deficit is commonly used in practice by most of the economies. It means there are positive implications of fiscal deficit. But the countries are cautious in maintaining such a deficit within the limit because if such a deficit crosses the limit, it will create serious negative consequences for the economy.
Positive aspects/implications/effects of fiscal deficit
- Mobilization of resources in the prioritized and strategic sector/area.
- Maintaining macroeconomic stability:
- Inflation → Domestic borrowing
- Recession → External borrowing
- Supports for economic growth and creating aggregate demand.
- Infrastructure development and other capital formation through increased investment financed by borrowing.
- Helps to develop the money and capital market through the issue of T-bills and bonds.
- Helps to maintain balanced regional and sectoral development through increased government investment.
- Improves the resource mobilization capacity of the government.
- Minimizes tax burden on society.
- Improves bilateral and multilateral relations.
- Increase in the FOREX reserve and support for maintaining external sector stability.
Negative Aspects of Fiscal Deficit
- Increases inflationary pressure in the economy due to increased government expenditure and aggregate demand.
- The crowding out effect of private investment due to increased interest rates.
- Capital flight in the form of external debt financing.
- Threat to macroeconomic stability due to excess borrowing.
- Interference in the domestic issues and priority by the external lender.
- Reduced credit rating and discourages foreign investment.
- Erosion in the country’s image globally.
- Chances of being insolvent due to excessive external borrowing.
- May compromise the domestic need and priority in order to manage external debt repayment.
- The issue of corruption, political motivation, and populism is related to the larger size of the budget.
Sources of Financing Fiscal Deficit: Sources of Deficit Financing
The government uses internal and external sources to finance the fiscal deficit, where the developed countries mostly rely on internal sources, while developing countries rely on external and internal sources.
1. Internal Sources:
- Market borrowing by issuing T-Bills and Bonds.
- Institutional borrowing: Borrowing from corporate institutions.
- Force lending to the government, especially during the sources crisis.
- Use of the past reserve of the government in any way.
- Sell out the government property to meet the funding gap.
2. External Sources:
- Borrowing from the bilateral and multilateral development partners such as JICA, USAID, China Aid, World Bank, and IMF.
- Borrowing from the foreign financial market by issuing government bills and bonds in foreign currency.
Other Posts