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How rising inflation could help Govt balance its fiscal maths

GS Paper 3

Syllabus: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment

 

Source: IE

 

Direction: The article discusses how high inflation can benefit the government’s fiscal calculations.

 

Context: Even though the high inflation rate of above 6% for most of this fiscal year forced the RBI and the government to take action to bring it under control, this may soon become a blessing in disguise.

The FY 2022-23 fiscal maths has benefited from:

  • Strong nominal GDP (which takes into account inflation) growth of around 16% vs budgeted 11%;
  • Above target tax collections due to better growth, reopening boost, formalisation, and tighter compliance;
  • Pick up in nominal GST collections, which have helped to offset lower RBI dividends, fuel excise cuts, higher subsidies, and divestment miss.

 

How can this be a blessing for the government?

  • The fiscal deficit is expected to be higher in absolute terms by at least Rs 1 lakh crore, but the gains from a rise in nominal GDP (which takes into account inflation) will help in meeting the budget target (4% of GDP).

What will be the effect on Budget 2023-24 maths?

  • The disadvantage of this gain would be visible in the next fiscal year when a likely slower growth rate and sluggish tax revenues would harm the government’s budget maths.
  • Slower real and nominal GDP growth would occur amid weakening demand conditions, a slowing global economy, and the normalisation of base effects from the pandemic.
Some important economic concepts
Gross Domestic Product (GDP)Nominal vs Real GDPFiscal deficit
●        GDP is defined as the total monetary or market value of all finished goods and services produced within the borders of a country during a given time period.

●        Sub-components of GDP (GDP = Consumption + Investment + Government final consumption expenditure + Net exports)

●        Thus, GDP tracks total demand to determine the value of the entire output in the economy.

●        The actual observable variable is nominal GDP, which is estimated using current market prices.

●        However, Real GDP is a derived indicator that is determined using constant 2011-12 prices after adjusting for inflation.

●        Real GDP = Nominal GDP – Inflation Rate.

●        It is vital to examine what has occurred to nominal GDP from a budgetary standpoint.

●        A fiscal deficit is a difference between a government’s income and its spending.

●        It is essentially a measure of the health of the government’s finances, tracking the amount of money a government must borrow from the market to cover its expenses.

Insta Links:

Inflation

 

Prelims: (UPSC 2013)

Which one of the following is likely to be one of the most inflationary in its effects?

  1. Repayment of public debt
  2. Borrowing from the public to finance a budget deficit
  3. Borrowing from the banks to finance a budget deficit
  4. Creation of new money to finance a budget deficit

 

Ans: 4