The dual deficits in question are the fiscal deficit and the current account deficit. Both have a tendency to rise to levels considered risky whenever external shocks occur, both for macroeconomic stability and especially for the maintenance of the rupee-dollar exchange rate.
The Finance Ministry report has red-flagged how both have risen at the same time, as tax cuts announced as a relief on rising fuel prices, and the fertilizer subsidy bill from the budget due to a sharp rise in international prices. likely to be large. After Russia invades Ukraine, it will make it difficult for it to keep the fiscal deficit below the target level, as a result, the current account deficit may also widen, leading to a cycle of widening deficit and a weakening rupee.
To understand these concepts properly, it is useful to first understand some elementary macroeconomics. Gross domestic product (GDP) is the value of each final good or service produced in the economy, usually a year or a quarter (the value of intermediate goods is included in the value of the final goods, so this double-counting amount to add) will be). Everything that is produced is consumed, invested or exported. What if something is produced but has not yet been sold for end use, so you may wonder: Does it have any value? Inventories are part of investment, and hence are taken into account when you calculate investments.
So, GDP is the sum total of consumption, investment and exports, right? Wrong. Portions of what you consume or invest in are imported. Many components of your smartphone were imported, the Marvel Comic Universe movie you consumed has a large import component, most of the oil from which domestic refineries produce petrol and diesel is imported, a lot of plant and machinery imports are done. So, GDP is the sum of consumption, investment and exports, less imports. Call the difference between exports and imports net exports.
So, GDP = Consumption + Investment + Net Exports
Suppose we remove consumption from both sides of the equation (if you subtract the exact same values from both sides, the equality remains), we get:
GDP — Consumption = Investment + Net Exports
That which is not consumed from what is produced, we call it saving.
So, we get:
Savings = Investment + Net Exports
When we include all services including financial, labor and real estate services in business services, the net exports are what is called the current account balance.
Savings = Investment + Current Account Balance
Let’s remove investment from both sides of the equation, and we have:
Savings – Investment = Current Account Balance
If saving is greater than investment, the value on the left hand side of the equation will be positive. This means that the right hand side must also have a positive value. In other words, the current account will be in surplus. When a country runs a current account surplus, it exports savings to other countries instead of using all domestic savings for domestic investment.
If savings equal investment, the current account will be in perfect balance, with exports of goods and services matching imports of goods and services.
If the left hand side of the equation is negative, that is, if investment is greater than savings, then the current account will be in deficit. The economy is investing more than what is left over and drawing in external savings to make that additional investment possible.
India usually runs a current account deficit. Which actually means that India invests more than household savings. That excess is equal to the value of the current account deficit.
When you import more than you export, someone has to finance the difference that you can’t pay to use the export proceeds. It could be that you are in a position to deplete your foreign exchange reserves, or that you borrow, including those wishing to finance their exports.
Growth stems from investment. The more you invest, the faster you grow. For a growing economy like India, it is good to have a moderate current account deficit, so that we can invest more than we save and go faster than we can on the strength of household savings.
Why be liberal, why not widen the current account deficit as much as possible, supplement household savings as much as possible and grow rapidly? People are willing to give you capital, either in the form of equity or debt, because they expect the capital to be served. If the economy shows signs of borrowing beyond its debt servicing capacity, not only will further debt dry up, some existing loans may also be in trouble. Your credit rating will drop, further loans will become more expensive or unattainable, holders of Indian bonds will start dumping them, reducing their value and thus increasing the yield. The rupee exchange rate would come under pressure from speculators in the money market and capital could be pulled out, meaning an increase in the outflow of dollars from the economy.
After a long time, the way to health is through rehab. The macroeconomic counterpart is being brought under the IMF’s stipulation to gain credibility. Sri Lanka and Pakistan are yet to enter rehab.
Not all investments lead to growth. Therefore, adding investment only to widen the savings-investment gap and, thus, the current account deficit, does not ensure that the economy will generate enough capital to meet the large current account deficit. Came for
Now, we have an idea why the current account deficit can be a problem.
How is fiscal deficit related to current account deficit?
Fiscal deficit, on the face of it, is the borrowing that the government makes to finance expenditure in excess of its non-borrowing receipts. Non-borrowing receipts include capital receipts (loans repaid, assets sold) and current receipts (tax revenue, dividends from state undertakings, interest income from past loans, spectrum usage charges, etc.).
The government borrows to spend. It is spent on the same goods and services on which the private sector spends. If government expenditure is limited to those goods and services that remain after the private sector has met all its requirements, then government borrowing will not be a problem. However, if government spending can spare the private sector after meeting its own needs, then the combined demand for goods and services will be greater than produced. This excess demand would be resolved in two ways: one, there would be an increase in prices, and two, there would be more imports to meet the demand, which would widen the current account deficit.
The government needs to borrow because its investment plans exceed its savings. The Government of India runs a revenue deficit, which means that its current expenditure exceeds its current income. So, it consists in saving instead of saving (Suppose the government suddenly discovers all the black money in the economy and taxes it, then it will have a revenue reward and big savings left after meeting its expenses, with which to finance its investments.) This borrowing represents a claim on the savings of the private sector.
It is important to appreciate that savings here represent the goods and services produced but not consumed and not only so represent their financial equivalent in terms of Rs.
What government borrowing represents a claim on non-government savings is not clear to us, because government consumption and investment are transacted through money. Suppose the government took charge of the goods and services it needed, such as taxation. There would be no pressure if the goods and services so availed could be released by the non-government sector after meeting their needs. But if the government wants goods and services that the private sector also wants, and takes them, then in any case, the private sector will have to cut back on its needs. But in real life the government does not do various types of taxation. The credit system generates enough credit for both the government and the private sector to increase demand for the same set of goods and services, and to bid up their prices or force additional imports. A larger fiscal deficit could, in fact, spur private investment, as the government outsmarts private players for goods and services. That would be undesirable.
In the event of sluggish private sector demand for goods and services, a strong fiscal deficit would prop up the economy rather than create additional demand. When the private sector sees increasing demand, it can start expanding capacity. This is what the crowding out of the fiscal deficit in private investment means.
Whether the fiscal deficit is good or bad, whether it is too high or too low, depends on the level of private investment in the economy. If the fiscal deficit is large in times of rising ‘animal spirits’ among entrepreneurs willing to make large investments, the relentless demand from the government will result in slashing private investment, creating inflation and widening the current account deficit, bringing in additional would to. Savings to meet the additional demand for government borrowing and savings arising from private demand.
Regarding the 3% of GDP target for fiscal deficit, in economic terms, nothing is sacrosanct. The desirable level of fiscal deficit depends on the investment capacity of the private sector.
An excessive fiscal deficit, which leaves the private sector with more goods and services than it needs to meet its own needs, can create a wide current account deficit, as the economy tends to increase household savings with the savings of other countries. wants (one’s current account surplus has to be balanced by someone else’s deficit).
As oil and food become expensive due to the Ukraine war and supply disruptions, India’s import bill will increase. If exports do not increase, the current account deficit will widen – unless there is a reduction in investment, to narrow the investment-savings gap. Keeping double deficit under control is the art of macroeconomic management. Whenever external shocks occur, India’s double deficit usually escalates in tandem. The last time this happened was in 2013 when the US Fed signaled a ‘taper tantrum’ phase that it would prematurely end the global financial crisis of the 2008 quantitative easing program. Both deficits raised concerns about India’s macroeconomic stability, leading to a run down on the rupee, before the Manmohan Singh-led government and the Reserve Bank of India took steps to narrow them, and put India into a ‘fragile five’ economy. In the process of sacrificing GDP growth rate. But avert crisis.