Inflation impact on Fiscal Deficit – UPSC GS3

Status of Fiscal Deficit in FY22:
According to the finance ministry data, government is likely to achieve 6.8 per cent fiscal deficit target for FY22. It is due to following factors:
  1. The aggregate borrowing of the states is 10 per cent less than their projections.
  2. The average cost of borrowing of the centre is within the acceptable limit.
  3. Sale of BPCL and the listing of LIC may bring in the projected Rs 1.75 trillion to the government receipts.
  4. A higher inflation (consumer price index or wholesale price index).
  5. A higher-than-expected tax revenue.
How a higher inflation affects fiscal deficit?
A fiscal deficit is a difference between total expenditure and total receipts of the government. It is calculated as a percentage of the nominal GDP. The Nominal GDP is calculated on the current prices, which includes the inflation component. Higher inflation thus s shrinks the fiscal deficit.
However, in the long run, high inflation will have a negative impact on the fiscal deficit, due to the consequent rise in the interest rates.
What are the challenges in the way of fiscal consolidation?
Fiscal consolidation, which includes rationalizing the government expenditure, attracts foreign borrowers. However, it will not be an easy task due to following factors:
  • Increasing food and fertilizer subsidies on social sector schemes like PM Garib Kalyan Anna Yojana.
  • The bar on Government’s expenditures on salary and office expenses has been lifted.
  • States and centres will have to cut their capital expenditures, which may halt the boost to the economy.
Scroll to Top