Fiscal deficit is defined as the difference between the total expenditures and the total earned revenue (through direct and indirect taxes) by the Government. Fiscal deficit is mainly measured as a percentage of total GDP.
Here in this write up, we will check the importance of keeping fiscal deficit within proper limit and what can be the after effects of higher fiscal deficit. Government fund the fiscal deficit by issuing government bonds and treasury bills for which it has to pay interest rate or coupon payment annually or semi-annually. The main buyers of these government bonds or treasury bills are foreign creditors and Indian banks and financial institutions.
Also during financial crisis time, Government has to increase the spending and provide fiscal stimulus to support the economy. To do so, Government uses fiscal deficit to borrow more money from the market.
The financial effects of higher fiscal deficit are follows
Higher fiscal deficit increases the government borrowing from the money market which increases the interest rate in the money market due to higher supply. Government has to pay more interest rate to sell the bonds and treasury bills.
Higher fiscal deficit leads to higher borrowing which also leads to higher interest payment and debt burden on the government. Higher borrowings also increase the payout in terms of interest and coupon payment on the bonds.
If the fiscal deficit and market interest rate are already high, then it becomes tough for government to borrow cheap money easily to support the economy during financial crisis time.
Global credit rating companies and foreign creditors view lower fiscal deficit as a favorable parameter for any country’s sovereign bond rating. Higher fiscal deficit lowers the credit rating of the country and hurts the sentiment of the global creditors and investors.
Also lower fiscal deficit increases confidence among the domestic and foreign investors about the credibility of the government to run a country’s balance sheet. Maintaining lower fiscal deficit without hurting the economic growth is always favorable to the investors.
Higher fiscal deficit increases foreign fund inflow inside the domestic market and makes local currency to appreciate. Local currency appreciation increases import and decreases export.
These are the main reasons to keep fiscal deficit as lower as possible. But it should not be such that to hurt the economic growth. Within certain limit if the interest rate is very low, it is always advisable to borrow from the market at cheaper rate and spend in the economy for long term benefits. The efficiency lies in how the government is using the borrowed money at cheaper rate to achieve strong and sustainable economic growth for the country.