Types of deficits and FRBM Act

The fiscal deficit this financial year is expected to touch 6 per cent of the country’s gross domestic product (GDP) -- the highest in 14 years – because of falling tax collections and rising expenditure. Frbm Breached

Deficits
What is revenue deficit?

Revenue deficit is the gap between revenue expenditure and revenue receipts. It is therefore the borrowing undertaken to meet the current needs of the Government.

What is fiscal deficit?

Fiscal deficit is the total borrowing of the Government. It is equal to the total expenditure by the Government minus the total receipts.

What is wrong with running deficits?

Running deficits today means promising to pay interest on them tomorrow. Today, the Central Government borrows about Rs 4.51 lakh crore. Out of this, Rs 2.25 lakh crore is paid out as interest on previous borrowing. At this rate, all additional borrowing will be going only to service the debt!

What is FRBM?

The FRBM is the Fiscal Responsibility and Budget Management Act. It was passed by Parliament in 2003. Under this Act, the Government was required to bring down revenue deficit to zero by 2007-08.

How is fiscal deficit different from revenue deficit?

Every government raises resources for funding its expenditure. The major sources for funds are taxes and borrowings. Borrowings could be from the Reserve Bank of India (RBI), from the public by floating bonds, financial institutions, banks and even foreign institutions. These borrowings constitute public debt and fiscal deficit is a measure of borrowings by the government in a financial year.
In budgetary arithmetic, it is total expenditure minus the sum of revenue receipts, recoveries of loans and other receipts such as proceeds...
When the government is also running a revenue deficit, then it has to borrow not just to meet the spending on the capital account but also to finance the revenue deficit.
Currently, two-thirds of the fiscal deficit is on account of the revenue deficit! That is why the FRBM puts emphasis on cutting the revenue deficit. Once this is zero, total borrowing will come down substantially.

How will it help in redeeming the fiscal situation?

The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Union government to stick to the deficit targets.
As per the target, revenue deficit, which is revenue expenditure minus revenue receipts, should have reduced to nil in five years beginning 2004-05. Each year, i.e the government was required to reduce the revenue deficit by 0.5% of the GDP.

How are these targets monitored?

The Rules have mid-year targets for fiscal and revenue deficits. The Rules required the government to restrict fiscal and revenue deficit to 45% of budget estimates at the end of September (first half of the financial year).
In case of a breach of either of the two limits, the FM will be required to explain to Parliament the reasons for the breach, the corrective steps, as well as the proposals for funding the additional deficit.

Do economies need a fiscal deficit?

Many economists, including Lord Keynes, had advocated the need for small fiscal deficits to boost an economy, especially in times of crises. What it means is that government should raise public investment by investing borrowed funds. This exercise is also called pump-priming. The basic purpose of the whole exercise is to accelerate the growth of an economy by public intervention. Hence, there is nothing fundamentally wrong with a fiscal deficit, provided the cost of intervention does not exceed the emanating benefits.
The darker side of the story is that the borrowed funds, which always remain on tap, have to be repaid. And pending repayment, these loans have to be serviced.
Ideally, the yield on investment on borrowed funds must be higher than the cost of borrowing.
For example, if the government borrows Rs 100 at 10%, it must earn more than 10% on investment of Rs 100. In that situation, fiscal deficit will not pose any problem.
However, the government spends money on all kinds of projects, including social sector schemes, where it is impossible to calculate the rate of return at least in monetary terms. So, one will never know whether the borrowed funds are being invested wisely.