Why in news?
- Despite the strain on government finances due to the COVID-19 pandemic, there is no credible proposal to amend the legislation meant to control the fiscal deficit, Chairman of the 15th Finance Commission said.
- Speaking to presspersons after a two-day meeting of the Commission’s Economic Advisory Council said the government was currently looking to see how to ameliorate economic hardship while staying within the broad framework of the existing law.
Background
- While presenting the Union Budget in February 2020, the Finance Minister had invoked the Fiscal Responsibility and Budget Management Act’s escape clause to relax the fiscal deficit target for 2020-21 by 0.5% percentage points to 3.5% of the GDP.
- If the government wishes to increase spending further in light of the current crisis, as many economists have recommended, it may need to amend the Act.
- The State governments have been demanding that their own 3% fiscal deficit targets be relaxed to 4% or even 5%, to give them elbow room in dealing with the impact of the lockdown.
Need for new law
- Economic Advisory Council members felt that options need to be considered for financing the additional deficit.
- It is important to ensure that the State governments get access to adequate funds to undertake their fight against the pandemic, they said, adding that different States may come out of the pandemic’s impact in different stages.
- Council members all felt that earlier projections of real GDP growth will need to be revised downwards considerably.
- Noting that the lockdown’s impact on public finances will be significant, with a large shortfall in tax and other revenues, the Council recommended a nuanced fiscal response, with a focus not just on the size but the design of any stimulus package.
- A support mechanism for cash-starved small enterprises needs to be a top priority, along with partial loan guarantees and other measures to protect non-banking financial companies, the Council said.
What is fiscal deficit?
It is the difference between the Revenue Receipts plus Non-debt Capital Receipts (NDCR) and the total expenditure.
In other words, fiscal deficit is “reflective of the total borrowing requirements of Government”.
What is the significance of fiscal deficit?
- In the economy, there is a limited pool of investible savings. These savings are used by financial institutions like banks to lend to private businesses (both big and small) and the governments (Centre and state).
- If the fiscal deficit ratio is too high, it implies that there is a lesser amount of money left in the market for private entrepreneurs and businesses to borrow.
- Lesser amount of this money, in turn, leads to higher rates of interest charged on such lending.
- So, simply put, a higher fiscal deficit means higher borrowing by the government, which, in turn, mean higher interest rates in the economy.
- A high fiscal deficit and higher interest rates would also mean that the efforts of the Reserve Bank of India to reduce interest rates are undone.
