Fiscal Deficit & Current Account Deficit – Our glaring twin deficits

India is in a lot of trouble economically now but the government is trying to find a way out of this. Will it be able to?

All of us, while growing up, found economics a boring subject & kept ourselves studiously away from politics. And with time we must have realized that  both of them affect us tremendously

 

Today, the economy (and not just India’s but the world economy) is in major trouble. We have been discussing a lot about inflation and the falling rupee but all these factors have led to two new problems.

An increasing fiscal deficit and current account deficit.

Here we are making an attempt to explain what they mean and how the government plans to solve these issues.

As always, our first priority is explaining what these two jargons mean.

Deficit is a problem that almost all salaried individuals have faced one time or the other. It is when your expenditure exceeds your income.

The government also faces this problem sometimes. That’s when it is called a fiscal deficit.

Current account deficit is a little more specific, it is the amount by which the country’s import expenditure exceeds export revenue.

Now, these are not new issues at all. India, and for that matter many other countries, face these issues a lot of times. In fact, sometimes this deficit is also encouraged so, what’s the problem now? Why is everyone worrying about this “twin deficit”?

 Why Is There A Twin Deficit Issue?

Well, first, both fiscal deficit and current account deficit are set to reach record highs, especially the current account deficit which could hit a 10 year high soon, according to a report by Morgan Stanley.

Second, these problems coupled with high inflation and falling rupee spell major trouble for us. If the deficit continues to grow and the rupee continues to fall, we soon may not have enough money for fuel imports and other expenses.

But how did we get into this situation in the first place?

The global economic situation is to blame for that. The current Russia-Ukraine war has increased the costs of our imports by a lot. To make these imported products affordable for the public the government has had to waive off import taxes and increase subsidies.

That is the major reason for our fiscal and current account deficit to grow. And thanks to the falling rupee, this deficit will keep growing (because we will have to keep paying more money for the same amount of goods).

So, how can we solve this problem?

Well, the most common way to solve this problem would be to borrow more money. That’s what most economies do. But with countries around the world raising interest rates, borrowing would not be the best option right now (since we would have to pay more interest).

But the government has found another way to boost revenues.

It is now imposing a tax on the export of crude oil. Though this is mainly to increase the supply of fuel in the domestic markets, it will also help boost the government’s revenue.

What’s more, it is also imposing a windfall tax to cash in on the gains made by oil companies due to high oil prices.

Windfall Tax…..

Remember how your parents used to take away the extra pocket money your relatives gave you when you visited? Windfall tax is something like that.

It’s simply a tax on the excess profits made by any company or sector at a given time.

And this windfall tax is set to earn the government somewhere around Rs 67000-Rs 69000 crores, making up for most of the Rs 1 lakh crores, the government lost due to removal of excise duty on oil products.

But this alone obviously won’t help bridge our fiscal and current account deficit. In fact, an export duty will further curb exports increasing our current account deficit.

Government’s Gameplan…..

According to a recent interview of Finance Minister Nirmala Sitharaman, the government is focusing on capital expenditure. Which is basically spending more on building major assets like factories, roadways, and railways.

But then, how will spending more help us?

The age old gospel truth, money attracts more money.

Capital expenditure (or capex if you want to be all cool and jargony) boosts the economy by building assets that generate employment, attract private and foreign investment and open new revenue streams for the government.

By generating more employment they also increase people’s purchasing power, which further increases demand and boosts the economy.

Some facts & figures to substantiate this theory

The numbers claim that every Rs. 1 spent on capex earns Rs 2.45 in the next year and Rs 3.14 in the year after that.

This could help us eventually bridge our fiscal deficit before it becomes a major problem.

However, when the government is more focused on capital expenditure (it aims to spend Rs 7.5 trillion this year), companies often have to cut down on capital expenditure. That is because demand for money in the market increases and more people are willing to lend to the government (because it is more reliable & creditworthy).

So, borrowing costs for companies increase. This means they spend less, so they hire less, kind of bringing us back to square one.

Also, this high capex could increase our inflation problem by injecting more liquidity in the economy.

But promoting growth is also important, otherwise we are just inviting stagflation. As you notice, there are no straight answers for the economic trouble we are in right now.

The government and the RBI will just have to make what they think are the correct moves and wait for the repercussions.

And why just India. Central banks and governments across the world are currently engaged in an intense game of chess with the larger economic forces. And though game theory could potentially predict what the possible outcomes will be, we will simply have to wait and watch to see if we can checkmate inflation or will it knock us down.

Summarizing – GOI is trying really hard to fight its twin deficit problem by imposing new taxes , but new steps are only causing newer problems. It has actually become the proverbial, Hobson’s choice.