India’s emerging twin deficit problem

India’s emerging twin deficit problem

Subject: Economy

Section: Fiscal policy

Context: The World is looking at a distinct possibility of widespread stagflation. India, however, is at low risk of stagflation, owing to its prudent stabilization policies, a report by Finance Ministry.

But, given the uncertainties, the report highlights two key areas of concern for the Indian economy: the fiscal deficit and the current account deficit (or CAD)

Concept:

What is twin deficit?

• It refers to a nation’s current account deficits and a simultaneous fiscal deficit.

Fiscal deficit

• It is the amount of money that the government has to borrow in any year to fill the gap between its expenditures and revenues.
• Fiscal deficit = Total Expenditure – Total revenue (Excluding the borrowings)

Impact of Fiscal Deficit:

• Higher levels of fiscal deficit implies that the crowding out of the private sector investment
• At a time when the government want to sustain a private sector investment cycle, borrowing more than what it budgeted will be counter-productive

What could be done to reduce the fiscal deficit?

• To reduce the revenue expenditure (it is the money government spends just to meet its daily needs). Rationalizing revenue expenditure not only for protecting growth supportive capex but also for avoiding fiscal slippages.
• Capex” or capital expenditure essentially refers to money spent towards creating productive assets such as roads, buildings, ports etc
• Capex has a much bigger multiplier effect on the overall GDP growth than revenue expenditure

Current account deficit

The current account essentially refers to two specific sub-parts:

Import and Export of goods — this is the “trade account”.

Import and export of services — this is called the “invisibles account

• If a country imports more goods than it exports, it is said to have a trade account deficit.
• A deficit implies that more money is going out of the country than coming in via the trade of physical goods
• Similarly, the same country could be earning a surplus on the invisibles account — that is, it could be exporting more services than importing
• The net effect of a trade account and the invisibles account is a deficit, then it is called a current account deficit or CAD

Impact of Current Account Deficit (CAD):

• Increasing CAD tends to weaken the domestic currency because a CAD implies more dollars (or foreign currencies) are being demanded than rupees
• Costlier imports such as crude oil and other commodities will not only widen the CAD but also put downward pressure on the rupee
• A weaker rupee will, in turn, make future imports costlier.
• In response to higher interest rates in the western economies especially the US, foreign portfolio investors (FPI) continue to pull out money from the Indian markets, that too will hurt the rupee and further increase CAD

Fiscal slippage:

Fiscal slippage in simple terms is any deviation in expenditure from the expected.

• For example, if government has targeted to keep the fiscal deficit within 3.3% percent of GDP, but if it crosses that limit, it’s called ‘Fiscal Slippage’