Types of Deficits: Fiscal, Revenue, Primary, Trade, Budgetary and Monetised Deficits | UPSC

Introduction:

• India has set a target to narrow its fiscal deficit to 5.1% in the fiscal year 2024/25, after lowering the current year’s deficit to 5.8% of gross domestic product (GDP).
• A deficit occurs when a government spends more than it receives in a given period, usually a year.
• To understand the types of deficits a government incurs, we first need to understand the terms: capital receipts/expenditure, and revenue receipts/expenditure.

Understanding basics

a) Capital Receipts

• These include the loans taken by the government or recovery of the loans given by it to others.
• Capital receipts can be both non-debt and debt receipts.
• The capital receipts have a nature of non-recurrence. 

i) Non-debt Capital Receipts

• Non-debt capital receipts are basically the recovered loans and other receipts of the government.
• These are part of capital receipts that do not generate additional liabilities and which do not incur any future repayment burden for the government. These include:
  • • Recoveries of loans and advances given to state governments, union territories and foreign governments
    • Disinvestment proceeds from public sector undertakings
    • Money accrued to the Union government from listing of central government companies and issue of bonus shares

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ii) Debt Capital Receipts

• Debt-creating capital receipts are basically the loans taken by the government from the general public, foreign governments and the Reserve Bank of India (RBI).
• These are ones that involve higher liabilities and future payment commitments of the government. Most of the capital receipts of the government are debt receipts.
• Other examples of debt capital receipts are: Market loans, treasury bills, cash management bills, ways and means advances, securities against small savings, state provident funds, internal debt (relief debt, saving bonds, post office life insurance fund, public account other than state provident funds), external debt (loans from international financial institutions like IMF, World Bank etc. and bilateral debt from countries), issuance of special securities to public-sector banks, etc.

b) Capital Expenditure

• Capital Expenditure is the money spent for asset creation and liabilities reduction.
• It includes spending on construction of highways, metro rail network, bridges dams and school buildings etc.
• It includes the loans given to union territories and states, and repayment of borrowings.
• Capital expenditure also covers the acquisition of equipment and machinery by the government, including those for defence purposes.
• Capital expenditure also includes investment by the government that yields profits or dividend in future.
• Capital expenditure includes money spent on the following:
  • • Acquiring fixed and intangible assets
    • Upgrading an existing asset
    • Repairing an existing asset
    • Repayment of loan
• Along with the creation of assets, repayment of loan is also capital expenditure, as it reduces liability.
• Capital expenditure has a significant ‘crowding in’ effect, and helps to increase private capital expenditures as well.

c) Revenue Expenditure

• Revenue Expenditure is that part of government expenditure that neither creates assets nor reduces any liability of the government.
• Payment of salaries, wages, pensions, subsidies, and other services and interest on loans/past debt fall in this category as revenue expenditure examples.
• All grants given to state governments and union territories are also treated as revenue expenditure, even if some of these grants may be used for the creation of capital assets.
• Also, expenses incurred by the government for its operational needs are considered revenue expenditure.
• Revenue Expenditure is recurring in nature. High revenue expenditure impedes developmental efforts.
  • • High revenue expenditure means that the government machinery is spending too much money on sustaining itself, rather than creating assets required to achieve high economic growth.

d) Revenue Receipts

• Revenue receipts involve receipts that are not associated with increase in liabilities and comprise revenue from taxes and non-tax sources.
• While taxation is a primary source of income for the government, it also earns some recurring income other than tax, which is called non-tax revenue.
• While sources of tax revenue consist of few but bulk direct and indirect taxes, the number of sources of non-tax revenue are very large with wide variance in the quantum of collections per source.
• Although there are large sources of non-tax revenue, the quantum of collection per source is much less than that of tax collections.
• Note: Nearly three-fourths of the central government’s receipts come from tax and non-tax revenues, while one-fourth comes from capital receipts that include non-debt capital receipts and borrowings.
  • • Non-debt capital receipts account for around 3% of the central government’s total receipts.

Types of deficits

a) Fiscal Deficit

• Fiscal deficit is the difference between the government’s total expenditure and its total receipts excluding borrowing.
  • • It is also defined as the difference between the total expenditure of the government and its total income.
• It is the difference between the total non-debt creating receipts (the Revenue Receipts plus Non-Debt Capital Receipts, NDCR) and the total expenditure.
• The difference between the total expenditure of Government by way of revenue, capital and loans net of repayments on the one hand and revenue receipts of Government and capital receipts which are not in the nature of borrowing but which accrue to Government on the other, constitutes gross fiscal deficit.
  • • Gross fiscal deficit = Total expenditure – (Revenue receipts + Non-debt creating capital receipts)
• The fiscal deficit will have to be financed through borrowing. Thus, it indicates the total borrowing requirements of the government from all sources.
  • • From the financing side, Gross fiscal deficit = Net borrowing at home + Borrowing from RBI + Borrowing from abroad
• Net fiscal deficitcan be arrived at by deducting net domestic lending from gross fiscal deficit.

Sources of Financing Fiscal Deficit

• Sources of financing fiscal deficit can be both debt receipts and draw down by the government of its cash balance with the RBI.
• In the Debt Receipts, the various sources in decreasing order are usually like:
  • • Market Borrowings (G-securities)
    • Securities against Small Savings
    • Short term borrowings (Treasury Bills etc.)
    • Other Receipts (Internal Debts and Public Account)
    • External Debt
    • State Provident Funds
    • Draw Down of Cash Balance

b) Revenue Deficit

• It refers to the excess of revenue expenditure over revenue receipts.
  • • Revenue deficit = Revenue expenditure – Revenue receipts.
• The revenue deficit includes only such transactions that affect the current income and expenditure of the government.
• When the government incurs a revenue deficit, it implies that the government is dis-saving and is using up the savings of the other sectors of the economy to finance a part of its consumption expenditure.
• This situation means that the government will have to borrow not only to finance its investment but also its consumption requirements.
• This will lead to a build-up of debt and interest liabilities and force the government, eventually, to cut expenditure.
  • • Since a major part of revenue expenditure is committed expenditure, it cannot be reduced.
    • Often the government reduces productive capital expenditure or welfare expenditure. This would mean lower growth and adverse welfare implications.
• Revenue deficit signifies that government’s own earning is insufficient to meet normal functioning of government departments and provision of services.
• A large share of revenue deficit in fiscal deficit indicates that a large part of borrowing is being used to meet its consumption expenditure needs rather than investment.
  • • It indicates increase in liabilities of the Central Government without increase in the assets of that Government.
• Revenue deficit is a part of fiscal deficit (Fiscal Deficit = Revenue Deficit + Capital Expenditure – Non Debt Creating Capital Receipts).
• The difference between fiscal deficit and revenue deficit is the government’s capital expenditure.

c) Effective Revenue Deficit

• In the 2012-13 budget, the concept of effective revenue deficit was introduced that excluded grants for the creation of capital assets from conventional revenue deficit.
• Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets.
  • • Grants for creation of capital assets are defined as “the grants-in-aid given by the Central Government to the State Governments, constitutional authorities or bodies, autonomous bodies and other scheme implementing agencies for creation of capital assets which are owned by the said entities”.
• The concept of effective revenue deficit has been suggested by the Rangarajan Committee on Public Expenditure.
• It is aimed to deduct the money used out of borrowing to finance capital expenditure.
• The concept has been introduced to ascertain the actual deficit in the revenue account after adjusting for expenditure of capital nature.
• Focusing on this will help in reducing the consumptive component of revenue deficit and create space for increased capital spending.

d) Trade deficit

• A nation has a trade deficit if the total value of goods and services it imports is greater than the total value of those it exports.

e) Primary Deficit

• Primary deficit is the fiscal deficit minus the interest payments i.e., Gross primary deficit = Gross fiscal deficit – Net interest liabilities
  • • Net interest liabilities consist of interest payments minus interest receipts by the government on net domestic lending.
• Primary deficit is also defined as the difference between the current year’s fiscal deficit (total income – total expenditure of the government) and the interest paid on the borrowings of the previous year.
  • • Primary Deficit = Fiscal Deficit (Total expenditure – Total income of the government) – Interest payments (of previous borrowings).
• The borrowing requirement of the government includes interest obligations on accumulated debt. Thus, the goal of measuring primary deficit is to focus on present fiscal imbalances.
• To obtain an estimate of borrowing on account of current expenditures exceeding revenues, we need to calculate what has been called the primary deficit.

What does Primary Deficit indicate?

• Primary deficit is measured to know the amount of borrowing that the government can utilize, excluding the interest payments.
• A decrease in primary deficit shows progress towards fiscal health.
• Note that the difference between the primary deficit and fiscal deficit reflects the amount of interest payment on public debt generated in the past.
• Hence, when the primary deficit is zero, the fiscal deficit becomes equal to the interest payment.
  • • This means that the government has resorted to borrowings just to pay off the interest payments. Further, nothing is added to the existing loan.
• The decreasing order of the deficits is generally like:
  • • Fiscal Deficit
    • Revenue Deficit
    • Effective Revenue Deficit
    • Primary Deficit

f) Monetised Deficit

• Monetised deficit is the monetary support the Reserve Bank of India (RBI) extends to the Centre as part of the government’s borrowing programme.
  • • In other words, the term refers to the purchase of government bonds by the central bank to finance the spending needs of the government.
• Also known as debt monetisation, the exercise leads to an increase in total money supply in the system, and hence inflation, as RBI creates fresh money to purchase the bonds.
• The same bonds are later used to bring down inflation as they are sold in the open market. This helps RBI suck excess money out of the market and rein in rising prices.

g) Budgetary Deficit

• It is the difference between all receipts and expenses in both revenue and capital account of the government. Budgetary deficit is usually expressed as a percentage of GDP.
• Budget Deficit and Monetized Deficit are the deficits on the basis of financing.
  • • Fiscal Deficit, Primary Deficit, Revenue Deficit and Effective Revenue Deficit are the deficits on the basis of type of transactions.

h) Current account deficit

• Factor income: It is determined by subtracting income made by citizens of a country on their foreign investments from income earned by foreigners on their investments within the country.
• Current/Financial transfers: They include interest earnings, foreign remittances, donations, aids and grants, official assistance, pensions etc.
• Current account deficit/balance (CAD/CAB) = trade deficit + factor income + financial transfers.
• CAD/CAB can also be defined as: (X−M) + (NY+NCT) where:
  • • X = Exports of goods and services
    • M=Imports of goods and services
    • NY=Net income abroad
    • NCT=Net current transfers

Miscellaneous

a) Balance of payments

• The balance of payments is the sum of all transactions between a nation and all of its international trading partners.

b) Fiscal expansion

• Fiscal expansion is generally defined as an increase in economic spending owing to actions taken by the government.
• Expansionary fiscal policy can also lead to inflation because of the higher demand in the economy.
• A general increase in overall spending can cause the cash flow leaving the country to increase as consumers and the government both purchase more. This increases the debit side of the balance of payments.
• Fiscal expansion generally worsens the Inflation and Balance of payments.

c) Fiscal Consolidation

• Fiscal consolidation describes government policy intended to reduce deficits and the accumulation of debt.

References:

• https://www.indiabudget.gov.in/budget2011-2012/ub2011-12/rec/cr.pdf
• https://cag.gov.in/uploads/old_reports/union/union_compliance/2001/Civil/2001_book1/chapter5.pdf
• https://www.business-standard.com/about/what-is-monetised-deficit
• https://economictimes.indiatimes.com/definition/budgetary-deficit
• https://ec.europa.eu/eurostat/statistics-explained/index.php?title=Glossary:Fiscal_consolidation
• https://www.indiabudget.gov.in/doc/Budget_at_Glance/bag2.pdf

Practice MCQs for UPSC Prelims:

Q. In a normal Union Budget, the decreasing order of the deficits is generally like:

(a) Fiscal Deficit > Revenue Deficit > Effective Revenue Deficit > Primary Deficit

(b) Primary Deficit > Fiscal Deficit > Revenue Deficit > Effective Revenue Deficit

(c) Revenue Deficit > Effective Revenue Deficit > Primary Deficit > Fiscal Deficit

(d) Fiscal Deficit > Primary Deficit > Revenue Deficit > Effective Revenue Deficit

Answer: a

Explanation:

• Fiscal Deficit is the difference between the Revenue Receipts plus Non-Debt Capital Receipts (NDCR) and the total expenditure. It is reflective of the total borrowing requirement of Government.
• Revenue Deficit refers to the excess of revenue expenditure over revenue receipts.
• Effective Revenue Deficit is the difference between Revenue Deficit and Grants for Creation of Capital Assets.
• Primary Deficit is measured as Fiscal Deficit less interest payments.
• The decreasing order of the deficits is generally like:
  • • Fiscal Deficit
    • Revenue Deficit
    • Effective Revenue Deficit
    • Primary Deficit

Therefore, option (a) is the correct answer.

Relevance: India has set a target to narrow its fiscal deficit to 5.1% in the fiscal year 2024/25.

Subject: Current Affairs | Economy

Level of Difficulty: Moderate | Factual

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Practice Questions for UPSC Mains:

Topic: Government Budgeting (GS Mains Paper 3)

Q. What are the key implications of the fiscal deficit of the Union government, and how does it influence economic stability, fiscal policy, and public perception of governance? (Answer in 250 words)

Introduction:

• The deficit of the Union government, often referred to as the fiscal deficit, holds significant implications for economic stability, fiscal policy, and public perception of governance.

Implications for Economic Stability:

• The fiscal deficit reflects the variance between government expenditures and revenues. A high deficit indicates that the government is spending more than it is earning, leading to borrowing. While some level of deficit spending can stimulate economic growth through investments in infrastructure, education, and healthcare, persistent deficits can destabilize the economy.
• Firstly, high deficits can lead to increased government borrowing, which, if not managed prudently, can escalate interest payments, burdening future generations and crowding out private investment. This can lead to higher interest rates, dampening consumer spending and business investments, ultimately hampering economic stability.
• Furthermore, deficits can fuel inflationary pressures, especially when financed by printing money or excessive borrowing from the central bank. Inflation erodes purchasing power, reduces consumer confidence, and distorts resource allocation, ultimately undermining long-term economic stability.

Implications for Fiscal Policy:

• Fiscal deficits constrain the government’s ability to pursue expansionary fiscal policies during economic downturns. High deficits limit fiscal space, reducing the government’s capacity to deploy counter-cyclical measures such as tax cuts or increased spending to stimulate demand and mitigate recessions.
• Moreover, persistent deficits can lead to unsustainable debt levels, constraining future fiscal policy options. Governments may be forced to implement austerity measures, such as spending cuts or tax hikes, to reduce deficits, which can further impede economic recovery and exacerbate social inequalities.

Implications for Public Perception of Governance:

• The management of fiscal deficits influences public perception of governance effectiveness and credibility. High deficits, especially when perceived as stemming from mismanagement or corruption, erode trust in government institutions and leadership.
• Conversely, responsible fiscal management, characterized by transparency, accountability, and prudent fiscal policies, enhances public confidence in governance. Governments perceived as effectively managing deficits while prioritizing public welfare garner support and legitimacy, strengthening social cohesion and political stability.

Conclusion:

• In conclusion, the deficit of the Union government carries multifaceted implications, impacting economic stability, fiscal policy flexibility, and public trust in governance.
• Addressing deficits requires a delicate balance between promoting growth, ensuring fiscal sustainability, and maintaining public confidence, underscoring the complexities of fiscal governance in modern democracies.