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A Project Report on India’s Fiscal Deficit and

Its Impact on Gross Domestic Product

Submitted by:
Apurva Sharma
Section - A
Seat No – 60
Enroll No –10BSPHH010148

INDEX
Serial No Topic Page No.

1
1 Objective 3

2 Methodology 4

3 Introduction 5-6

4 Fiscal Deficit Trends In 7


India

5 Reasons for Increase 8-9


In Fiscal Deficit

6 Government Revenue 10
& Expenditure

7 Correlation 11

8 Financing Fiscal 12-13


Deficit

9 Ways to Reduce Fiscal 14


Deficit

10 References 15

2
OBJECTIVE

The objective of the study was to analyze the current trends in India’s fiscal deficit and Gross
Domestic product and also to study the impact of increasing fiscal deficit on the various
components of Gross Domestic Product.

3
METHODOLOGY

The project was a mixture of theoretical as well as practical knowledge.

Secondary data required was for the project was collected from various websites and books of
reputed authors.

The project commenced from sorting the data and arranging them in perfect order.

4
INTRODUCTION

A Deficit is the amount by which a particular sum of money falls short of the required amount
of money.

Fiscal deficit is an economic funda, where the Government's total expenditure exceeds the
revenue generated. It is the difference between the Government's total receipts (excluding
borrowing) and total expenditure. It gives the signal to the government regarding the total
borrowing requirements from all sources.

An increase in fiscal deficit means that the government is not able to meet its total expenditure
out of its total receipts.

The Gross Domestic Product (GDP) is the amount of goods and services produced in a year in
a country. It is the market value of all final goods and services made within the borders of a
country in a year.

Under the Expenditure Method:

GDP = C + I + G + (X-M)

Where,

C = Private Consumption

It is the largest GDP component in the economy, consisting of private household final
consumption expenditure in the economy. These personal expenditures fall under one of the
following categories: durable goods and non-durable goods, and services. Examples include
food, rent, jewelry, and medical expenses but do not include the purchase of new housing.

I = Gross Investment

It includes business investment in equipments and does not include exchanges of existing assets.
Examples include construction of a new mine, purchase of software, or purchase of machinery
and equipment for a factory. Spending by households (not government) on new houses is also
included in Investment. Buying financial products is classed as 'saving', as opposed to
investment. This avoids double-counting, if one buys shares in a company, and the company uses
the money received to buy plant, equipment, etc., the amount will be counted toward GDP when
the company spends the money on those things.

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G = Government Spending

It is the sum of government expenditures on final goods and services. It includes salaries
of public sector employees, purchase of weapons for the military, and any investment
expenditure by a government. It does not include any transfer payments.

X = Exports

It represents gross exports. GDP considers the amount a country produces, including goods and
services produced for other nations' consumption, therefore exports are added.

M = Imports

It represents gross imports. Imports are subtracted since imported goods will be included in the
terms G, I, or C, and must be deducted to avoid including foreign supply as domestic.

Fiscal Deficit Trends in India

Through the bar graph we can see that the fiscal deficit remained more or less constant and
below the Rs 150000 crore mark during the period 2000-08. But after that from the year
2009 the fiscal deficit in India has shot to Rs 350000 crore mark and has kept increasing in
the following years.

Fiscal Deficit as a percentage of GDP

The reason for this sudden increase fiscal deficit since 2008 can
be attributed to the following reasons:
1. Tax Cuts
In 2007-08 period the tax rate was the highest at 11.99 but since then in the following
years the tax rate has come down from 11.99 to an average tax rate of 10.59 but it has
started to increase in the 2010-11 period.

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2. Stimulus Packages

Due to global financial crisis the Government of India announced the first stimulus
package on 7th December 2008. Since the Government has announced three more
stimulus packages as of 2009.
These measures were taken to support the micro, small and medium sector enterprises.
The priority was to re-assure the people of the country of the stability of the
financial system in general and also of the safety of bank deposits in particular.
For this steps were taken to infuse liquidity into the banking system and
also to address problems being faced by various non-bank financing companies. These
steps have ensured that the financial system is functioning effectively without suffering
the kind of loss of confidence experienced in
the industrialized world.

3. 6th Pay Commission

There was a hike of 21% in the salaries of around 50 lakh employees of the Government
of India. The wage increased the financial implications for the Centre by Rs. 17,798 crore
annually and the arrears costed Rs. 29,373 crore.

4. High defence expenditure

There is a sharp increase in the defence expenditure since 2008 from Rs 92500 crore in
2008 to Rs 1108749 crore in 2010-11.

5. Huge Infrastructure expenditure

A large number of infrastructure projects were cleared for implementation in the Public
Private Partnership mode. In order to support financing of such projects, Government of
India decided to authorize the India Infrastructure Finance Company Limited (IIFCL) to
raise Rs. 10,000 crore through tax free bonds by 31st March 2009. These funds were to be

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used by IIFCL to refinance bank lending of longer maturity to eligible infrastructure
projects, particularly in highways and port sectors.

6. Agriculture loan waive off


The Government of India announced agriculture loan waiver of Rs 71000cr to bail out
nearly 4 million small and marginal farmers.

Government Revenue and Expenditure

Through this bar graph we can see that the Government Spending is at all times more than
the Government Receipts since 2000.This leads to fiscal deficit in the country.

GDP at MP and Gross Fiscal Deficit

Correlation between Gross Fiscal Deficit and GDP

Gross Fiscal
Deficit GDP at MP
Gross Fiscal Deficit Pearson Correlation 1 .816(*)
Sig. (2-tailed)
N 6
GDP at MP Pearson Correlation .816(*) 1
Sig. (2-tailed) .048
N 6
* Correlation is significant at the 0.05 level (2-tailed).

There is relatively high positive correlation of .816 between Gross Fiscal Deficit and Gross
Domestic Product which means as fiscal deficit increases GDP also increases.

C = Increased Government spending leads to circulation of more money in the economy


which in turn leads to more money in the hands of the consumer to purchase the products and

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services. Hence, final consumption of the households increases. But supply cannot vary in
the short term, so there is a temporary mismatch of demand & supply in the economy which
exerts an upward pressure on inflation.

I = Due to an increase in interest rates there is a decrease in private investment

G = This can be explained through increased government spending on defence,


infrastructure, loan wave offs, etc.

These all lead to an increase in Gross Domestic Product.

Financing Fiscal Deficit

The fiscal deficit Year External Finance Internal Finance


can be financed
through 2004-05 14753 111041
borrowings from
2005-06 7472 138963
the Reserve Bank
of India which is 2006-07 8472 134101
also called deficit 2007-08 9315 117597
financing or
2008-09 11015 325977
money generation
and market 2009-10 16535 397506
borrowings from 2010-11 22464 358944
the money market,
which is mainly
from banks.

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1) The Increase in fiscal deficit causes the interest rates to rise in the
economy.
To reduce the Fiscal Deficit government borrows from the money market. Large
amount of borrowings by government results in higher interest rates. Higher
interest rates crowds out the private investment which means lower private
consumption. Also, higher borrowings by Government reduce liquidity in the
economy, leaving
fewer opportunities for
Year Rate banks to lend to private
2004 11 players.
2005 10.75
2006 10.75
2007 12.5
2008 12.75
2009 12.5
2010 12

2) It also results in rise in Inflation rates.

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This is because the part of the fiscal deficit which is financed by borrowing from the
RBI leads to an increase in the stock of money and a higher money stock
automatically leads to inflation since more money chases the same good.

Year Rate
200
3.80 %
4
200
4.20 %
5
200
4.20 %
6
200
5.30 %
7
200
6.40 %
8
200
8.30 %
9
201 10.90
0 %

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Ways to Reduce Fiscal Deficit

• Reduction in Expenditure

• Cutting down on Stimulus Packages

• Sale of sick Public Sector Units(PSU’s) – Disinvestment

• Increase in tax rates which will lead to an increase in tax revenue.

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References

1. www.rbi.org.in

2. www.indexmundi.com

3. Macroeconomics - Dornbusch,Fischer,Startz

4. Business Beacon

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