The finance ministry recently raised an alarm over the possible re-emergence of the twin deficit problem in the economy. This concern, shared in its ‘Monthly Economic Review’, identifies heightened global commodity prices and an increasing subsidy burden as major contributors to both the fiscal deficit and the Current Account Deficit (CAD). Amid these economic challenges, the government is also addressing the prospect of fiscal slippage in the present fiscal year for the first time.
Major Highlights of the Finance Ministry’s Report
The report sheds light on a potential risk of widespread stagflation worldwide. Despite this threat, India’s chances of falling prey to stagflation remain low due to its shrewd stabilization strategies. Additionally, the Indian financial markets have experienced a substantial outflow of foreign investment over the past eight months. This situation has been further complicated by a weakened GDP growth projection. The report also warns of a 5% chance of outflows under portfolio investments of 7.7 %of GDP and retractions in short-term trade credit making up 3.9 %of GDP in a possible black swan event.
Impact of the Twin Deficit Issue
The twin deficit problem, particularly the escalating current account deficit, could potentially amplify the effects of more expensive imports and depreciate the rupee. This development would subsequently intensify external imbalances.
Potential Remedies for the Situation
The government could counteract these issues by reducing revenue expenditure, boosting domestic manufacturing, and cutting down on superfluous importation. To prevent fiscal slippage, it should structure its capital and revenue expenditures wisely and seek to balance the budget.
Understanding Key Terms
The term ‘fiscal deficit’ refers to the gap between the government’s spending requirements and its earnings, equating to the amount it needs to borrow annually. The CAD measures the inflow and outflow of goods, services, and investments from the country and features in its Balance of Payments (BOP). The twin deficit problem is the combination of CAD and fiscal or budget deficit. A high fiscal deficit often results in an increased CAD and vice versa. Stagflation describes a situation marked by slow economic growth, high unemployment, and high inflation. A black swan event implies the occurrence of all historical adverse shocks concurrently, leading to a catastrophic storm.
Relevant UPSC Civil Services Questions from Previous Years
In a 2010 governance-related question, candidates were asked to determine which strategies among encouraging Foreign Direct Investment (FDI) inflows, privatizing higher educational institutions, downsizing the bureaucracy, and selling public sector shares could help control India’s fiscal deficit. Answer D (downsizing the bureaucracy and selling public sector shares) was the correct response as these methods directly contribute to reducing the fiscal deficit. The impact of FDI inflows on the fiscal deficit cannot be accurately determined without knowing their direction and effect. Although privatizing higher education may improve the situation, its contribution to lowering the fiscal deficit may not be significant. Hence, only statements 3 and 4 were deemed correct.