Understanding fiscal deficits

Fiscal deficit is a phrase that is bandied about every year, but not very well understood – both in terms of how to arrive at it, but also in terms of what it means.

In the first part of today’s post, I’ll explain how to arrive at it. In the second part, I’ll rely on a couple of lines from an excellent article written by Rathin Roy a while ago.

---

I work at the Gokhale Institute of Politics and Economics, Pune. This means that while I continue to be employed at the Institute, a salary will be credited into my bank account every month. I can also choose to augment my income by, say, breaking a fixed deposit, or by taking a loan. The first part is my “recurring” income, while the latter is a one-time income.

I stay in a rented accommodation. This means I have to pay rent every month. I also have to buy groceries, pay for utilities, and pay the salaries of everybody who works at my household. But also, every now and then, I can, say, buy a car. Or a laptop. Or a house. These are not monthly expenses – at least not in my household they aren’t! The first set of expenses are “recurring” expenses, while the latter are one-time expenses.

Taken together, what matters in my household is that I must be able to arrange for ways to meet my monthly expenses. Let’s write down some very simple numbers:

1. Assume that my recurring expenses are one lakh rupees – one hundred thousand INR. (Groceries, rent, salaries, petrol, eating out etc etc)
2. Assume that for the month of March, my capital expenses are also one lakh rupees. (Maybe I’ve chosen to buy the latest M1 Macbook. One can dream.)
3. So, my expenses, all told, are two lakh rupees for the month of March 2021.
4. Assume that Gokhale pays me seventy thousand rupees as my salary. Assume that I augment this income by teaching courses in a couple of other colleges. Let’s assume that I earn one lakh rupees through this recurring income (salary plus visiting faculty income is one lakh per month)
5. I have no other sources of income. So: 1+2 are my total expenses, against which my total income is 1 lakh rupees (4).
6. Let’s say I am unwilling to break into any of my savings to purchase this laptop, and choose to borrow the amount instead. That is, no capital income, only borrowing.

So, in essence, the amount that I need to borrow after all possible sources of income have been thought of, in order to meet my total expenses…

That borrowing is my “fiscal deficit” for the month of March 2021.

Homework: to check if you have understood this, try reading the budget at a glance document, and see if you get how Nirmala Sitharaman and team arrived at the fiscal deficit for the government. Page 3 in the PDF.*

---

OK, so now we know what the fiscal deficit is, and how to go about arriving at it. But is a high fiscal deficit a good thing or a bad thing, and how does one decide?

Well, it depends on what you are borrowing for! For example, as I often say when I am talking to students, they are and should be running a fiscal deficit in their own, personal lives. They’re spending money (rent, food, movies, college fees) but not earning anything at the moment. The idea is that this money is being spent in order to acquire skills that enable them to earn much more in the future. Much more, in fact, than they spend on acquiring that education – or that, at any rate, is the plan.

But what if they instead spend an equivalent amount of money, but not to acquire an education. They spend this money, instead, on buying a Honda Gold Wing. (Yes, I know education isn’t quite that expensive just yet.)

That would be problematic, because you are taking on debt, but for acquiring a depreciating asset (a bike that gets worse over time) and not an appreciating one (your education and your years of experience get more valuable over time).

Or as Rathin Roy put it in a recent Business Standard column:

If the government is merely borrowing to fund consumption expenditure then this is difficult to justify.

https://www.business-standard.com/article/opinion/political-economy-of-fiscal-responsibility-121010701581_1.html

and a little while later, in the same piece…

For example, the “golden rule,” which states that governments must finance consumption expenditure out of revenue receipts and borrow only for investment.

https://www.business-standard.com/article/opinion/political-economy-of-fiscal-responsibility-121010701581_1.html

There is much, much more to take away from Rathin Roy’s piece, of course (and I’ll write a follow-up piece later this week) – but as a first step towards understanding fiscal deficits, this is more than enough.

*If, for whatever reason, the budget at a glance document is not clear, let me know in the comments below. If more than ten people are interested, happy to arrange a quick video call about it (because, you know, there have been so few of ’em this past year!)