Some Basic Economics Lessons - Fiscal Deficit

      The Standard & Poors (S&P’s) had recently downgraded U.S. in their credit rating from AAA to AA+. After a week of the downgrade, Deven Sharma, then the president of S&P’s, got fired from the post (even though many newspapers quoted that he had step down) .
         

    The S&P’s report stated that “We have lowered our long-term sovereign credit rating on the United States of America to 'AA+' from 'AAA' and affirmed the 'A-1+' short-term rating.” It also stated further that “ The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics.”
                

     Many people criticised the downgrade of the U.S. credit rating and few people supported the downgrade of U.S. credit rating with statement that it is due to growing fiscal deficit in U.S.. Of course, it will be a very interesting topic do an analysis on the latter part and one can write a good article on it. But, that's not going to be done here now.

      Now let's go to the basic lesson and see what does fiscal deficit means, its components and what does it indicate to us?

    Fiscal deficit is an economic phenomenon, when Governments total expenditure exceeds its revenue. In simple terms, it is the difference between government's total receipts (excluding borrowing) and total expenditure. There are two primary component of Fiscal Deficit; they are Revenue Deficit & Capital Expenditure.

    Revenue deficit is defined as the actual net amount received (i.e. revenue minus expenditure) fails to meet the projected (or predicted) net amount to be received. In other words, when the actual amount of revenue received and/or the actual amount of expenditures do not tally with the projected revenue and expenditure figures. Capital Expenditure is famously known as CAPEX. It is the expenditure incurred for creating future benefits. In simple terms, the expenditure incurred to create physical assets like buildings, machineries, equipment’s, property etc.... A capital expenditure is incurred when the money is spent on either to buy fixed assets or to add to the value of an existing fixed asset.

    Fiscal deficit is an indicator to the government, about the total borrowing requirements from all sources.

Fiscal Deficit in India:

       In India, the fiscal deficit is financed by obtaining funds (money) from Reserve Bank of India (this is also called as deficit financing). The fiscal deficit is also financed by obtaining funds from the money market (primarily from banks). As per RBI Annual Report, the Fiscal Deficit for the year 2010-11 (Revised Estimates) is 7.7% (combined – Centre (5.1) and State (2.6)); whereas the Budget Estimates for 2011-12 is expected to be 6.8% (Centre - 4.6% & State - 2.2%)