Explained: What is fiscal deficit and what it means for economic stability

As of January 2025, India's fiscal deficit for FY25 is projected at 4.9 per cent of GDP, amounting to approximately Rs 16.1 trillion

A fiscal deficit occurs when a government’s total expenditures exceed its total income, excluding borrowings. This shortfall is a key indicator of financial health and economic policy. As of January 2025, India’s fiscal deficit for the financial year 2024-25 (FY25) is projected at 4.9 per cent of GDP, amounting to approximately Rs 16.1 trillion.

 

Despite a potential shortfall of Rs 1 to Rs 1.5 trillion in capital expenditure, this projection aligns with the government’s budget target. By early January 2025, the fiscal deficit had reached Rs 8.47 trillion, accounting for 52.5 per cent of the total fiscal deficit target for FY25 — a widening compared to the previous year. Analysts note that while the government strives to meet its target, actual outcomes depend on revenue collection and economic conditions.

 

 

India’s fiscal deficit compared globally

 

India’s fiscal deficit remains relatively high among emerging markets, alongside countries like Brazil and China. Developed economies such as the United States and the United Kingdom have reported significantly higher deficits, estimated at 8.8 per cent and 6.5 per cent of GDP in 2023, respectively, reflecting increased pandemic-related spending.

 

In contrast, countries like Germany and Australia exhibit stronger fiscal discipline, with deficits around 1 per cent to 2 per cent of GDP, showcasing varying economic policies and recovery strategies.

 

India’s fiscal deficit trends since 2014

 

India’s fiscal deficit trends over the past decade highlight shifts in financial management. In 2013-14, the deficit was 4.5 per cent of GDP, reducing to 3.4 per cent by 2018-19 due to fiscal consolidation. However, subdued revenue growth widened the deficit to 4.6 per cent in 2019-20.

 

The Covid-19 pandemic caused an unprecedented surge, with the deficit peaking at 9.3 per cent of GDP in 2020-21 due to increased healthcare and economic relief spending. Subsequent years showed steady improvement, with the fiscal deficit targeted at 5.6 per cent in 2023-24 and projected at 5.1 per cent in 2024-25. The government aims to reduce the deficit below 4.5 per cent by FY26.

 

How is fiscal deficit calculated?

 

The fiscal deficit is calculated as the difference between a government’s total expenditure and total revenue. Expenditures include revenue spending on salaries and operations, along with capital investments in infrastructure. Revenue sources include taxes and non-tax avenues such as fees and dividends.

 

Expressing the fiscal deficit as a percentage of GDP contextualises its size relative to the economy. While fiscal deficits can stimulate growth through investments in infrastructure and social programs, persistent deficits often lead to increased national debt.

 

Impact of persistent fiscal deficits

 

Prolonged fiscal deficits can strain public finances, raising the debt-to-GDP ratio and increasing debt-servicing costs. High borrowing levels may crowd out private sector investments, slow economic growth, and contribute to inflation. Investor confidence may also waver, potentially leading to higher borrowing costs and credit rating downgrades.

 

Reduced national savings limit resources for public services and long-term investments, hindering sustainable economic growth. Over time, unchecked fiscal deficits can exacerbate financial vulnerabilities and reduce the government’s ability to respond to future crises.

 

Causes of fiscal deficits

 

Fiscal deficits arise from several factors, including high government spending, inefficient tax collection, and economic downturns. Infrastructure investments and social welfare programs often increase expenditures, while ineffective tax policies reduce revenue.

 

During recessions, deficits typically widen as governments boost spending to support economic recovery. High existing debt levels further strain fiscal resources, with significant allocations to debt servicing. Tax cuts and changes in tax structures can also impact revenue generation, contributing to imbalances.