What is a Budget Deficit
![What is Budget Deficit](https://www.icicidirect.com/images//budget deficit big-202401311230237048732.jpg)
Given that ‘deficit’ means a ‘gap’ or a ‘shortfall’, a Budget Deficit occurs when a government’s revenue is less than its expenditure. It’s generally expressed as a percentage of the country’s GDP. A Budget Deficit is usually not considered good for the economy as it reflects poor management of the country’s finances. Governments run Budget Deficits to fund their infrastructure programmes, subsidies and interest payments. A Budget Deficit can also be an outcome of the country not having a wide-enough tax base, which limits the government’s sources of revenue. However, in times of distress, it may not be a bad idea to run a deficit to spur growth in the economy by ‘pump priming’ – government investing in infrastructure to create jobs and induce spending.
What causes a Budget Deficit?
Budget Deficit is caused when the government’s expenditure exceeds its revenue. This can happen due to various reasons. At times, governments indulge in populist schemes despite having limited sources of revenue. Such schemes may or may not be needed. Some examples include subsidies on foodgrains, fertilizers and energy (diesel and kerosene). Countries that have a small tax base are also prone to deficits. This can be due to leakages (people hiding their incomes) as well as the government giving exemptions to certain sections (say farmers). Often, countries raise huge debts to fund their programmes. This involves heavy interest payments, fuelling a vicious cycle. High interest payout leaves little money for investments in job-creating infrastructure projects. Thus, the economy stays depressed.
To spur investments and promote spending, governments also reduce taxes which can hurt its revenue. This can also add to a deficit. Higher spending on education and healthcare, though good for human development, as well as defence can also widen Budget Deficit.
Effects of a Budget Deficit
A Budget Deficit can have both negative and positive outcomes, though it is mostly harmful if carried on for a sustained period. More money in the hands of the people, a result of higher government spending leading to more jobs, can stoke inflation if the supply fails to match up. This creates distortions in the market. Creditors and rating agencies don’t like high Budget Deficits and can downgrade a country’s rating if they don’t see a visible improvement in the health of the economy. This can raise cost of capital and increase borrowing costs for bank, companies and individuals. To contain Budget Deficits, government may cut back on healthcare and education allocations, which can then hurt the quality of human capital in the country.
Increasing taxes is one way to curb Budget Deficits. Another idea can be to widen the tax base, but this is a long-term solution, and often fraught with risks as vested interests who are hurt by taxes may take to the streets against such a move.
What is the Relationship Between Budget Deficit and Stock Markets?
Stock markets look at the ‘quality’ of Budget Deficits to decide their response. Governments mostly fund Budget Deficits by borrowings. Government borrowings, if high, can crowd out private companies from the markets, thereby increasing their cost of capital and making their projects expensive to set up. This can depress the earnings of corporates, leaving less for dividend payouts, and hence hurt their stock price. Stock markets usually do not like too much spending in the form of subsidies on what it thinks is a wasteful expenditure, say subsidies on power and diesel.
At the same time, Budget Deficits that go into funding infrastructure projects like railways and ports are welcomed by the stock markets as investors see higher order inflows from the government and its entities to the private sector. These orders bring in revenue and profits for the private companies, translating into bigger dividends and higher share prices.
Types of Budget Deficits
There are broadly five types of Budget Deficits, namely Primary Deficit, Revenue Deficit, Fiscal Deficit, Current Account Deficit and Trade Deficit. Fiscal Deficit, Current Account Deficit and Trade Deficit are most important to determine the health of the economy.
Primary Deficit
It is the difference between the government’s total expenditure and total revenue, excluding interest payouts on borrowings.
Revenue Deficit
It occurs when the government’s revenue receipts are less than its total revenue expenditure.
Fiscal Deficit
The shortfall in the government’s total revenue compared to the total expenditure. It covers both revenue and capital transactions.
Trade Deficit
A trade deficit arises when the value of the goods and services a country imports is greater than the value of the goods and services it exports, leading to net outflow of foreign exchange.
Current Account Deficit
Current account deficit occurs when a country’s receipts from abroad (usually denominated in US dollars) is less than the payments it makes to foreign shores. Trade deficit is a large component of current account deficit, also popularly abbreviated as CAD. Beyond the regular trade in goods and services, foreign exchange also exchanges hands between countries on account of other transactions too. This includes remittances which is money sent by Indians living abroad back to India to their parents or investments by them in assets like property and stocks in India which brings precious US dollars into India. The vice versa can also happen i.e. Indians investing or sending money abroad. Similarly, students going from India to other countries have to deposit their fees in dollars which leads to outflow of foreign exchange. The net sum of trade deficit and these remittances to-and-fro is what is called CAD.
How Can You Mitigate Budget Deficit and Stock Market Impacts?
The government covers up for the shortfall in the Budget Deficit through borrowings. This raises borrowing costs for companies. In such a scenario, the central bank should take measures to increase liquidity for the companies and persuade commercial banks to lower interest rates. The central bank can also reduce requirement for reserves. This will free up funds for lending and soften the impact on companies.
The regulators including the government, the RBI and the SEBI can introduce steps to make it easier for companies to raise cheaper money through other means, including raising debt in foreign currency. Investors in stock markets can also increase their exposure to other asset classes like gold and real estate.
Strategies Used to Reduce Budget Deficits
Budget Deficits can be mitigated by implementing tax reforms for higher tax collections, increasing taxes, bringing more people under the tax net, reducing tax exemptions, closing loopholes, incentivising tax payments and ensuring tighter compliance. The government can also look to cut subsidies and nudge people to comply with tax laws. It can also look to substitute certain imports with local manufacturing and diversifying its sources. It can incentivise local manufacturing by making it easier to do business, simplifying laws and carrying out reforms.
Conclusion
Budget Deficit isn’t a very good thing, though it can be resorted to in times of distress when the government wants to spur spending on infrastructure to boost the economy and create jobs. It should never be allowed to cross reasonable limits as it causes inflation which ultimately hurts the common man.
Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.
Please Enter Email
Thank you.
Related content
![Gati Shakti Yojana](https://www.icicidirect.com/images//pm gati shakti yojanasmall-202402081916429476440.jpg)
Articles - Personal Finance
What is PM Gati Shakti Yojana
Hon'ble Finance Minister Nirmala Sitharaman unveiled three major economic railway corridors in the interim budget of 2024 for the PM Gati Shakti Yojana. Explore detailed information about PM Gati Shakti Yojana.
![Budget analysis](https://www.icicidirect.com/images//Trading Analysis- Small-202402061509132445913.jpg)
Articles - Personal Finance
Analysis of Interim Budget 2024
Get to knwo about the impact of interim budget 2024 and a detailed analysis in this article.
![Surplus Budget](https://www.icicidirect.com/images//surplus budget small-202401311347229916012.jpg)
Articles - Personal Finance
What Is a Surplus Budget
Learn about surplus budget and how a budget surplus impacts the economony.
![](https://www.icicidirect.com/images//MutualFund3-202304141610594686507.jpg)
Articles - Personal Finance
Union Budget 2024 – Trivia Part 2
The Union budget 2024 presentation is just around the corner. Let us look at some trivia regarding the Union budgets from the past
![](https://www.icicidirect.com/images//union budget and importance-202401301535002137583.jpg)
Articles - Personal Finance
What is Union Budget and Why it so Important
Learn about the what is the Union Budget in this article for a comprehensive information of its importance.
![](https://www.icicidirect.com/images//33-Personal-Finance-202304201242341418922.jpg)
Articles - Personal Finance
Union Budget: Key Details & Importance
As we come closer to February 1, the chatter around the expectations over Union Budget increases. From young college students looking to start their careers and small business owners to leading economists and industrialists, almost every Indian citizen keeps a tab on the Budget announcement. Let us discuss what is Union Budget and its importance for the economy.
![](https://www.icicidirect.com/Content/images/ilearn/article-placeholder.png)
Articles - Personal Finance
Impact of the Budget 2024 on Share Markets
The Union Budget 2024 got quite a cheer from the share market as major indices ended on a positive note. The NIFTY 50 and the Sensex benchmark indices gained during the Budget speech and finished green.
![](https://www.icicidirect.com/Content/images/ilearn/article-placeholder.png)
Articles - Personal Finance
What to Expect From Budget 2022 for Individuals and Salaried People
Over the last two years, individuals, especially salaried people, have taken quite a hit because of the pandemic. Work from home has not only increased expenses such as electricity and WiFi bills but has also put a strain on take-home salary. Naturally, people hope that the government will step in and ease some of these troubles through their Union Budget announcements.
![](https://www.icicidirect.com/Content/images/ilearn/article-placeholder.png)
Articles - Personal Finance
What is the impact of the Union Budget on the Indian Stock Markets
Indian stock markets are dynamic prone to ups and downs depending on a host of factors. Every year, one major event that impacts the equities and bond markets is the announcement of the Union Budget.
![](https://www.icicidirect.com/images//history of union budget small-202401231521137114375.jpg)
Articles - Personal Finance
History of the Union Budget in India
The ritual of presenting the Indian Budget is more than two centuries old, dating back to colonial times. India's first-ever Budget was presented by James Wilson in 1860, a Scottish economist and politician.
![](https://www.icicidirect.com/Content/images/ilearn/article-placeholder.png)
Articles - Personal Finance
10 Taxes Affected by Budget
Taxes are the most crucial and most significant source of revenue for the Government. The Government uses the revenues generated from taxes to provide basic facilities to its citizens and the nation's overall development. For example, construction of roads, buildings, infrastructure, public healthcare facilities, providing various subsidies, etc.
![](https://www.icicidirect.com/Content/images/ilearn/article-placeholder.png)
Articles - Personal Finance
What is Populist Budget
A budget typically meant to please people is known as a populist budget. It spends more on lucrative schemes that can increase the Government's fiscal deficit. Such a budget doesn't have any enduring positive impact on the country's economy.
![](https://www.icicidirect.com/images//budget components small-202401301116503507218.jpg)
Articles - Personal Finance
What are the Components of Union Budget
The Union Budget of India has two main components, each with two sub-components. To know more in detail, visit the link.
![](https://www.icicidirect.com/images//types of budgetsmall-202401301242073423847.jpg)
Articles - Personal Finance
Types of Budget in India
Deep dive into the three different types of government budgets and their impact on the economy.
![](https://www.icicidirect.com/Content/images/ilearn/article-placeholder.png)
Articles - Stocks
What is the Budget? Union Budget for Beginners
The Finance Minister of India presents the Union Budget on the first day of February every year. It is also known as the annual financial statement of the country. It contains the details of the revenue sources and expenses undertaken by the Government during the applicable financial year.
![](/Content/images/portfolio-img.webp)
COMMENT (0)