Importance of lowering budget deficit

B. Venkatesh

THE Union Budget is due for presentation in Parliament. As always, economists are pressing the Government to lower the estimated budget deficit for the coming fiscal.

Why is a low budget deficit important for an economy? Or, stated another way, what are the implications for a high Budget deficit?

A Budget deficit is a result of the government spending more than it earns. It borrows from the domestic credit market to bridge the deficit. Being the most creditworthy borrower in the country, the government can easily get funds from lenders/investors. As the supply of funds is limited, the government borrowing in the credit market results in lower money available to the private sector. When demand for funds is more than supply, the price of credit -- interest rates -- moves up.

When interest rates move up, businesses may be forced to abandon certain projects because of the high borrowing cost. Abandoning projects means lesser investments and that, in turn, may lead to fewer employment opportunities.

Now, let us look from the demand side. When government spends, it places money in the hands of the consumers. For instance, the government spending money to lay a highway will mean more income for the construction company and suppliers. That is good for the economy because it means higher demand for goods and services. And that could result in higher gross domestic product (GDP).

But what if the government spends more money for unproductive purposes, such as supporting sick businesses or providing subsidies? This may place more money with consumers without any increase in real output of goods. Such a situation could lead to price rise as more ``money chases too few goods''. And a persistent increase in price levels will lead to high inflation.

We all know how harmful inflation can be, especially if the economy is growing at a slow pace as ours is. That is why economists are asking the government to cut unproductive expenditure and thereby lower the Budget deficit.