MACRO ECONOMICS PROJECT

FISCAL DEFICIT CRISIS

Fiscal Deficit - An overview

It is a policy used by the government to influence the economy

through changes in government revenues (taxes) and government expenditure (spending). It shows the borrowing requirement of the Government
It has to borrow money from the public to meet the shortfall Control aggregate demand Ensure price stability Reduction in unemployment Stimulate growth of the economy.

Backdrop
Keynesian economists
The Keynesian view suggests an expansionary fiscal policy

Focuses on the relationship between aggregate income and

expenditure

Argument : economy's equilibrium level of output or real GDP

may not correspond to the natural level of real GDP.

Resulting deficits would be offset by the expanded economy

Classical economists
Questions the effects of the fiscal stimulus Reasons :

1. Crowding out of private investments 2. Decrease in net exports.

Exports decrease & imports increase

net decrease of net exports.

IS-LM Model Keynesian Cross Model

The shift in IS curve causes the interest rates to raise which results in a money market equilibrium below the level of output from the Keynesian cross model (crowding-out effect).

Classical Economist

Argument : prices and wages will fall, reducing producer costs and increasing the supply of real GDP until it is again equal to the natural level of real GDP. Self-regulating economy

The capital supply increases which decreases the exchange rate

FISCAL CRISIS IN THE INDIAN CONTEXT

Increase in Subsidies Excessive Government borrowings

Poor Performance of Public Sector

Defence Expenditure

Tax Evasion
Weak Revenue Mobilization

Consequences of the 1991 crisis

High fiscal deficits typically cause three problems

balance of payments crisis high interest rates (because of crowding out) high inflation

Debt Trap
Cut in Capital Expenditure Reduced Credit Rating Slow Economic Growth

BOP crisis
Balance of payments (BoP) accounts are an

accounting record of all monetary transactions between a country and the rest of the world

BOP crisis/currency crisis, occurs when a nation is

unable to pay for essential imports and/or service its debt repayments

Affects :

Rapid decline in the value of currency. Large capital inflows, which are associated at first with rapid economic growth

Inflation
High fiscal deficits drive down real effective exchange

rate.

Currency depreciation plus high interest rates cause high

inflation.

In times of inflation, deficit spending increases aggregate

demand, thus adding to inflationary pressures

As per study, Percentage point improvement in the ratio

of the fiscal balance to GDP leads to a 4.5% decline in inflation

High Interest Rate

A high deficit should crowd out private investment,

hence raise interest rates

Higher interest rates also can reduce the private

sector's demand for capital, thereby reducing the demand for commercial and retail borrowing.
When projected deficit to GDP ratio increases by

one percentage point, long-term interest rates increase by roughly 25 basis points.

Deficits vs GDP percentage

8 6 4 2 0 -2

Gross fiscal Deficit

Gross Primary Deficit

Revenue Deficit

Fiscal and revenue deficits were higher during the 1991 crisis. The new neo-liberal policies (reforms) included opening for

international trade and investment, deregulation, initiation of privatization, tax reforms, and inflation-controlling measures

Data analysis
GDP Growth rate (1983-84 to 1990-91)
12.0 10.0 8.0 6.0 4.0 2.0 0.0 0.00

GDP growth rate

y = -0.0032x + 6.1129 R = 0.0156

GDP Growth rate Linear (GDP Growth rate) 500.00

100.00 200.00 300.00 400.00 Gross fiscal deficit (Rs billion)

The fiscal deficit with GDP growth rate, it had a negative correlation before the 1991 crisis when fiscal deficit increased and growth decreased. Between 1991 and 2000, there was a slight positive correlation due to the reforms undertaken Between 2001 and 2011, again, there is a strict negative correlation between GFD and GDP

Data Analysis contd

Interest rates
16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 0 14

Inflation rate
12

Interest rates

Inflation rate

y = 0.7838x + 5.5443 R = 0.2268

Interest rates on Govt bonds Linear (Interest rates on Govt bonds)

10 8 6 4 2 0

y = 0.9018x + 2.7765 R = 0.136

Inflation rate Linear (Inflation rate)

5 GFD as % of GDP

10

5 GFD

10

Positive correlation between GFD and interest rates

Positive correlation between GFD and inflation

Current Fiscal deficit scenario

Government committed to restricting fiscal deficit to 5.3 per cent this fiscal CAD touched a 30-year high of 4.2 per cent of the GDP or USD 78 billion.

CAD occurs when the country's total imports and transfers are higher than its total exports and transfers crore or 5.1 per cent of GDP. In April-September 2012-13 fiscal, deficit touched 65.6 % of target. working towards achieving the Rs 30,000 crore target set for the year. USD 22.3 billion, which may prompt government to come out with incentives boost shipments.

The fiscal deficit for the current financial year projected at over Rs 5.13 lakh

Government raised Rs 932 crore through disinvestment in PSUs and

Continuing with its downward slide, exports dipped by 4.17 per cent to

Current Fiscal deficit scenario (contd)

The policy allowed an increase in outside investment

in many sectors- 51% FDI in multi-brand retail

Opening up the retail sector India $700 million in

investment and employ 20 million people within three years.

14% increase in diesel prices to reduce subsidies in

this sector bring the country's budget deficit under control

Conclusion and Suggestions

The focus should be on reducing the primary deficit as it

reflects the real situation of the Indian economy

RBI should concentrate on keeping a check on inflation

by using monetary policy tools to change money supply. increase in capital expenditure (infrastructure, human capital) is the long term solution to the problems new value added tax

Reduction of revenue expenditure (subsidies etc.) and

Further reduction in subsidies and implementing the

References
http://dbie.rbi.org.in/OpenDocument/opendoc/openDocument.jsp http://www.bloomberg.com/visual-data/fiscal-cliff/ http://www.economics.ox.ac.uk/Research/wp/pdf/paper120.pdf

http://www.indiastat.com/searchresult.aspx
http://www.rejournal.eu/Portals/0/Arhiva/JE%2042/Tiwari.pdf http://www.scribd.com/doc/53152000/59/importance-of-fiscal-deficit-

importance-of-fiscal-deficit

http://www.financialexpress.com/news/what-is-the-link-if-any-between-

fiscal-defict-and-inflation/79256

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