Explainer: What is fiscal deficit and how is it bridged?

The union budget presented by the central government is similar to any household budget. Like in any house, union budget has various expenditure heads—education, transport, instalments/interest on loans, health among others. Similarly, the government has many sources of earnings like taxes, dividend from companies it owns and other things.

The primary goal of planning a budget is to balance the earnings and expenditures. Now, think of a month when the budget you have planned for your house goes awry and the expenditure exceeds the earning. The difference between earning and expenditure in such cases is called a deficit.

Similarly, if the government faces such a scenario in a financial year when the total spending is more than the total revenue it generates, a deficit is created which is called a fiscal deficit. Conversely, if the revenue is more than the expenditure, the difference is called a (fiscal) surplus.

A fiscal deficit is also a measurement of the total borrowing needed by the government for a fiscal year.

Expressing fiscal deficit

Fiscal deficit in India is usually expressed in terms of percentage of the gross domestic product (GDP). For instance, let’s say, the difference between the expenditure and revenue of the government, i.e., deficit in FY 2016-17 is Rs 5 lakh crore. It could also be expressed as 3.5 percent of the GDP (of 2016, World Bank data).

How does the government bridge deficit?

There are various ways the government bridges the deficit, two prominent ways are: issuing treasury bills and bonds which are chiefly purchased by banks and other financial institutions.

Treasury bills are short-term (usually less one year) debt instruments issued by the government. Suppose, the government needs some funds to finance an election which was not planned in the budget. It will issue treasury bills or T-bills to borrow money from the capital market. These bills though do not pay any interest, are sold at a discount to their face value. At the time of maturity, the government pays the face value.

For example, a 91 day T-bill of Rs 100 face value is issued at say Rs 97.20. After maturity, on redeeming it gets an investor Rs 100. That means the profit of an investor is Rs 2.80.

On the other hand, bonds are long-term debt instruments which the government issues to finance major projects or bridge massive deficits. This instrument pays an interest to the investors and can also be traded in the market.