Government Spending

Government Spending

Subject: Economy

Context:

Rise in incremental spending–Govt stares at a steeper fiscal challenge.

Challenges in meeting the fiscal deficit target-fiscal deficit target of 6.4 per cent of the GDP for 2022-23.

• Additional expenditure sources:
  • Rozgar Mela — a recruitment drive for 10 lakh personnel across 38 ministries and departments.
  • Increase in the  allocations for security and administrative preparations for the G20 summit.
  • Higher subsidies for food, fuel and fertilisers –on account of  inflated subsidies bill and extension to the free foodgrains scheme.
  • Reduced space to cut spending by various ministries- due to higher transport costs due to high fuel prices.
• Other Concerns:
  • Chances of another aggressive rate hike by the Federal Reserve- cause capital outflows and the twin deficit challenge.

Positives- Fiscal target can be achieved?

• Higher tax revenues.
• GDP in nominal terms due to high inflation–Reduce fiscal deficit to GDP ratio.

Concept:

• Twin Deficit Problem: Current Account Deficit and Fiscal Deficit (also known as “budget deficit” is a situation when a nation’s expenditure exceeds its revenues) are together known as twin deficits and both often reinforce each other, i.e. a high fiscal deficit leads to higher CAD and vice versa.
• The fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing).
  • Fiscal deficit in layman’s terms corresponds to the borrowings and liabilities of the government.
  • As per the technical definition, Fiscal Deficit = Budgetary Deficit + Borrowings and Other Liabilities of the government.
  • Deficit differs from debt, which is an accumulation of yearly deficits. The elements of the fiscal deficit are revenue deficit and capital expenditure.
    • Revenue deficit is the difference between the government’s revenue expenditure and total revenue receipts.
• The current account deficit is a measurement of a country’s trade where the value of the goods and services it imports exceeds the value of the products it exports.
  • Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).

How the two deficits are related–the twin deficit hypothesis:

In macroeconomics, the twin deficits hypothesis or the twin deficits phenomenon  is the observation that, theoretically, there is a strong causal link between a nation’s government budget balance and its current account balance.

Explanation-

• Y=C+I+G+(X-M)
  • This equation  represents GDP because all the production in an economy (the left hand side of the equation) is used as consumption (C), investment (I), government spending (G), and goods that are exported in excess of imports (NX).
• Another equation defining GDP —Y=C+S+T (Y-C-T=S )
  • National income is also equal to output, and all individual income either goes to pay for consumption (C), to pay taxes (T), or is saved (S).
• Form first and second equation we get–S=G-T+NX+I or (S-I)+(T-G)=(NX)–shows the twin deficit relation 
  • (T-G) is negative, we have a budget deficit—If the budget deficit increases, and saving remains the same, then this last equation implies that either investment (I) must fall (see crowding out), or net exports (NX) must fall, causing a trade deficit. Hence, a budget deficit can also lead to a trade deficit, causing a twin deficit.