Deficits, Public Debt and the FRBM Act

Primary deficit = 16,95,768 minus interest payments of 14,03,972 = 2,91,796 crore rupees.

Effective revenue deficit = revenue deficit of 5,92,344 minus grants in aid for the creation of capital assets of 4,92,702 = 99,642 crore rupees.

Why the revenue deficit is the one that matters

Borrowing to build is defensible; borrowing to consume is not, and the reasoning is the "golden rule" of public finance.

If the Government borrows to build a road, a liability is created and so is an asset. The asset yields a stream of benefits, and often of revenue, over the years during which the debt is repaid, so the generation that repays is also the generation that uses the road. If the Government borrows to pay salaries and subsidies, the liability remains and nothing is left behind: the benefit is consumed now and the repayment falls on people who receive nothing from it.

A fiscal deficit equal to capital expenditure is therefore respectable; a large revenue deficit is not. It is for this reason that the FRBM Act originally required the revenue deficit to be eliminated altogether, and why the Budget reports the effective revenue deficit separately.

Debt: the stock behind the flow

A deficit is a flow and debt is a stock, and confusing them is the commonest error in this topic. The deficit is this year's borrowing; the debt is the accumulation of all past deficits not yet repaid. Every year's fiscal deficit adds to the debt, and the enlarged debt raises next year's interest bill, which is itself part of next year's expenditure.

Why the ratio of debt to gross domestic product is what is watched, and not the rupee figure. Debt is serviced out of a growing economy's income, so the burden depends on the size of the debt relative to national income. This produces the central arithmetic of debt sustainability: if the economy's nominal growth rate exceeds the average interest rate on the debt, the ratio falls even while borrowing continues, provided the primary deficit is contained; if the interest rate exceeds the growth rate, the ratio rises unless a primary surplus is run.

How Union borrowing is financed, from the Budget for 2026-27 in crore rupees: market borrowings through dated government securities 11,73,210; securities against small savings 3,86,772; treasury bills and other short term borrowing 1,30,000; State provident funds 3,500; external debt 15,385; other internal debt and public account items minus 45,801.

External debt is 15,385 crore rupees out of 16,63,066. India's Union borrowing is domestic and rupee denominated almost in its entirety. A country that borrows abroad in a foreign currency must earn that currency to repay, and a fall in its exchange rate increases the debt in its own money; that was the mechanism of the 1991 crisis described in [India's Foreign Trade Before 1991]. A country that borrows at home in its own currency faces no such risk.

The constitutional provisions

• Article 292. The executive power of the Union extends to borrowing upon the security of the Consolidated Fund of India within such limits, if any, as may from time to time be fixed by Parliament by law. The FRBM Act is that law.
• Article 293(1). A State may borrow within India upon the security of its Consolidated Fund within limits fixed by its Legislature. Note that a State may not borrow abroad.
• Article 293(3). A State which is indebted to the Union, or in respect of which the Union has given a guarantee, may not raise any loan without the consent of the Government of India. Since every State is so indebted, this is in practice a general requirement of Union consent, and it is treated further in [The GST Council, Grants and State Borrowing].

The Fiscal Responsibility and Budget Management Act 2003

Why a statute at all. The political incentive is always to spend now and borrow, because the benefit is immediate and visible and the cost is deferred and diffuse. A statute binds the Government to a path it would otherwise have every reason to abandon, and requires it to explain itself to Parliament when it deviates.

Section 3: the documents. The Central Government shall lay before both Houses of Parliament, along with the annual financial statement, a Medium term Fiscal Policy Statement, a Fiscal Policy Strategy Statement and a Macro economic Framework Statement, together with a Medium term Expenditure Framework Statement.

Section 4: the fiscal targets. The Central Government shall limit the fiscal deficit and endeavour to secure the prescribed debt path.

Section 4(2), the proviso: the escape clause. The fiscal deficit may exceed the target on grounds of:

• national security, act of war, national calamity;
• collapse of agriculture severely affecting farm output and incomes;
• structural reforms in the economy with unanticipated fiscal implications;
• decline in real output growth of a quarter by at least three percentage points below its average of the previous four quarters.

Section 4(3). Any deviation under the escape clause shall not exceed one half of one per cent of gross domestic product in a year.

Section 4(4), the symmetric provision. Where the increase in real output growth of a quarter is at least three percentage points above its average of the previous four quarters, the fiscal deficit shall fall by at least one quarter of one per cent of gross domestic product in a year. Students always remember the escape clause and never this one: the Act requires tightening in good times, not only permitting looseness in bad.

Section 4(5). When the escape clause is invoked, the Central Government shall lay before both Houses a statement of the reasons and the path of return to the targets.

Section 5: borrowing from the Reserve Bank. Sub section (1) provides that the Central Government shall not borrow from the Reserve Bank. Sub section (2) preserves the exception of ways and means advances, temporary advances to meet a mismatch between receipts and payments within the year.

Why section 5 exists and why it is the most important section for a student of money. Borrowing from the central bank means the central bank creates money to lend to the government, which is the monetisation of the deficit explained in [What Determines the Money Supply, and How the RBI Controls It]. It is the least painful way to finance expenditure and the most dangerous, because it expands high powered money without limit and has produced every great inflation in history. Section 5 closes that door and forces the Government into the market, where it must pay a rate of interest that other lenders set. That is a discipline no target by itself imposes.

Section 7: reporting and enforcement.

• Section 7(1). The Minister shall review the trends in receipts and expenditure half yearly and place the outcome before both Houses.
• Section 7(3)(a). Save as provided by the Act, no deviation in meeting the obligations cast on the Central Government shall be permissible without the approval of Parliament.

The Act's sanction is political, not judicial. Nothing in it makes a breach unlawful or gives anyone a right to sue. Its whole enforcement is the obligation to lay statements, review half yearly, and obtain Parliament's approval for a deviation, which is to say that its sanction is disclosure to the legislature. That is a real constraint on a government that must defend itself, and no constraint at all on one that does not mind.

Are deficits always bad

No, and an answer that says so is wrong.

The case for a deficit.

• In a recession, private spending falls and a deficit sustains demand, which is the whole of the Keynesian argument in [Why Trade Cycles Happen, and What Governments Do About Them].
• Capital expenditure financed by borrowing spreads the cost of a long lived asset over the generations that use it, which is fair as well as convenient.
• Automatic stabilisers produce a deficit in a downturn without any decision at all, since tax collections fall and welfare payments rise, and this is a feature and not a failure.

The case against.

• Crowding out. Government borrowing absorbs savings that might have financed private investment, and pushes interest rates up.
• The interest ratchet, which is India's real problem. Interest at 14,03,972 crore rupees pre empts about a quarter of expenditure before a single decision is made.
• Inflation, if the deficit is monetised, which section 5 is designed to prevent.
• Intergenerational unfairness, where the borrowing finances consumption rather than assets.

The honest position is that the composition matters more than the size. A fiscal deficit of 4.3 per cent of gross domestic product accompanied by effective capital expenditure of 17,14,523 crore rupees is a very different thing from the same deficit spent on subsidies, and this is precisely why the Budget reports four deficits and not one.

A worked example: three budgets with the same fiscal deficit

Three governments each run a fiscal deficit of 100 units.

• A borrows 100 and builds 100. Its revenue account balances and its whole deficit finances assets. This is the golden rule satisfied.
• B has a small primary deficit of 20, so its current decisions are nearly balanced, but it is crushed by an interest bill of 80 inherited from the past. Its problem is the stock of debt, not this year's choices.
• C borrows 100 and consumes 90 of it. Its primary deficit is large and its revenue deficit is nearly the whole of its borrowing. This is the worst of the three, although its headline fiscal deficit is identical.

The headline number is the same in all three cases and tells you almost nothing. That is the point of the chapter.

What beginners get wrong

"Fiscal deficit means total expenditure minus total receipts." It means total expenditure minus total receipts excluding borrowing. Include borrowing and the answer is always zero.

"Deficit and debt are the same." The deficit is a flow for one year; debt is the stock accumulated from past deficits.

"The primary deficit is a smaller version of the fiscal deficit." It is the fiscal deficit less interest, and it isolates the present Government's own decisions. India's fiscal deficit is 4.3 per cent of gross domestic product and its primary deficit 0.7, and the gap is the whole story.

"The escape clause lets the Government breach the target whenever it likes." Only on the four grounds in the proviso to section 4(2), by not more than 0.5 per cent of gross domestic product under section 4(3), and with a statement of reasons and a path of return laid before both Houses under section 4(5).

"The FRBM Act can be enforced in court." Its sanction is disclosure to Parliament and Parliament's approval for a deviation under section 7(3)(a).

"A deficit is always bad." In a recession it is the correct policy, and borrowing for capital expenditure is defensible in any year.

Limits

The targets have been reset repeatedly. The Act was amended in 2018 and the fiscal path has been revised since, most extensively after the pandemic, so a student should give the mechanism of section 4 rather than assert a fixed number as though it were permanent.

Union figures are not general government figures. The States borrow too, and the combined deficit and the combined debt are considerably larger than the Union's alone.

Off budget borrowing by public sector undertakings on the Government's behalf has at times kept expenditure out of the deficit, and the practice has been criticised by the Comptroller and Auditor General.

Budget Estimates are estimates. The Actuals for 2024-25 show a fiscal deficit of 4.8 per cent of gross domestic product where the Budget Estimates for 2026-27 show 4.3, and the outturn for 2026-27 will not be known for two years.

Quick revision

1. Fiscal deficit = total expenditure minus total receipts excluding debt receipts = the total borrowing requirement. 2026-27 BE: 16,95,768 crore rupees, 4.3 per cent of GDP.
2. Revenue deficit = revenue expenditure minus revenue receipts = borrowing for consumption. 5,92,344 crore, 1.5 per cent.
3. Effective revenue deficit = revenue deficit minus grants in aid for the creation of capital assets. 99,642 crore, 0.3 per cent.
4. Primary deficit = fiscal deficit minus interest payments = this year's own imbalance. 2,91,796 crore, 0.7 per cent. The 3.6 point gap from the fiscal deficit is the burden of past debt.
5. Deficit is a flow, debt a stock. Sustainability turns on whether nominal growth exceeds the average interest rate on the debt.
6. Constitution: article 292, Union borrowing within limits fixed by Parliament by law; article 293(1), State borrowing within India only; article 293(3), an indebted State needs the Union's consent to borrow.
7. FRBM Act 2003: s.3 four statements laid with the Budget; s.4 targets; proviso to s.4(2) escape clause on national security, act of war, national calamity, collapse of agriculture, structural reforms, or a quarter's growth three points below its four quarter average; s.4(3) deviation capped at 0.5 per cent of GDP; s.4(4) deficit must fall by 0.25 per cent when growth runs three points above; s.4(5) statement of reasons and path of return; s.5(1) no borrowing from the RBI, s.5(2) saving ways and means advances; s.7(1) half yearly review; s.7(3)(a) no deviation without Parliament's approval.
8. Section 5 is the anti monetisation provision and the most important one for a student of money.
9. Composition matters more than size: three budgets with the same fiscal deficit can be entirely different, which is why four deficits are reported.

Test yourself

1. Distinguish the fiscal deficit, the revenue deficit, the effective revenue deficit and the primary deficit, with the current figures. The fiscal deficit is the excess of total expenditure over total receipts excluding debt capital receipts, and it therefore measures the total borrowing requirement of the Government; for 2026-27 it is estimated at 16,95,768 crore rupees, or 4.3 per cent of gross domestic product. The revenue deficit is the excess of revenue expenditure over revenue receipts, and it measures the extent to which the Government is borrowing to meet current consumption rather than to create assets; it is estimated at 5,92,344 crore rupees, or 1.5 per cent. The effective revenue deficit is the revenue deficit less grants in aid given to States and others for the creation of capital assets, on the footing that although such a grant is revenue expenditure in the Union's books an asset is created at the other end; it is estimated at 99,642 crore rupees, or 0.3 per cent. The primary deficit is the fiscal deficit less interest payments, and it isolates the imbalance produced by the current year's decisions from the inherited burden of servicing past borrowing; it is estimated at 2,91,796 crore rupees, or 0.7 per cent. The distance between a fiscal deficit of 4.3 per cent and a primary deficit of 0.7 per cent is the measure of what past borrowing costs the present.

2. Why is the revenue deficit regarded as more serious than the fiscal deficit? Because of what the borrowing buys. A fiscal deficit incurred to finance capital expenditure creates a liability and an asset at the same time; the asset yields benefits, and often revenue, over the same years during which the debt is repaid, so the generation that bears the repayment is broadly the generation that enjoys the road, the railway or the power station. A revenue deficit is borrowing to meet expenditure that creates nothing: salaries, subsidies, interest and current grants are consumed as they are incurred, and when the debt falls due there is neither an asset nor a stream of income to meet it, so the burden falls on people who received no benefit whatever. This is the golden rule of public finance, that borrowing should be confined to capital account, and it is why the original scheme of the FRBM Act required the elimination of the revenue deficit altogether and why the Budget reports the effective revenue deficit as a separate line.

3. Explain the escape clause in the FRBM Act. Section 4 of the Act obliges the Central Government to limit the fiscal deficit and to endeavour to secure the prescribed debt path, but the proviso to section 4(2) permits the fiscal deficit to exceed the target on specified grounds, namely national security, act of war or national calamity; collapse of agriculture severely affecting farm output and incomes; structural reforms in the economy with unanticipated fiscal implications; or a decline in real output growth of a quarter by at least three percentage points below its average of the immediately preceding four quarters. The clause is not open ended. Section 4(3) provides that any deviation shall not exceed one half of one per cent of gross domestic product in a year, and section 4(5) requires the Government, when it invokes the clause, to lay before both Houses of Parliament a statement of the reasons for the deviation and of the path of return to the targets. Section 4(4) contains the corresponding obligation in the opposite direction, that where a quarter's real output growth is at least three percentage points above its four quarter average the fiscal deficit shall be reduced by at least one quarter of one per cent of gross domestic product in the year, so the Act requires consolidation in good times and does not merely excuse looseness in bad.

4. What does section 5 of the FRBM Act prohibit, and why does it matter? Section 5(1) provides that the Central Government shall not borrow from the Reserve Bank of India, subject to the exception preserved by section 5(2) for ways and means advances, which are temporary advances to bridge a mismatch between receipts and payments within the year. It matters because borrowing from the central bank is the monetisation of the deficit: the central bank creates reserves in order to lend to the government, high powered money expands, and the money supply expands with it through the multiplier. This is the cheapest possible way to finance expenditure, since it requires neither taxation nor the payment of a market rate of interest, and it is for that reason the most dangerous, having produced every great inflation in recorded economic history. By closing the door, section 5 forces the Government into the market for its borrowing, where it must pay a rate of interest determined by lenders who can refuse. That is a discipline which no numerical target can supply by itself, because a target can be revised while a market cannot be instructed.

5. Is a fiscal deficit necessarily undesirable? No. In a recession, private consumption and investment fall, and a government that cut its own expenditure to match its falling revenue would deepen the contraction; a deficit sustains aggregate demand and is the correct policy on the Keynesian analysis. Automatic stabilisers produce a deficit in a downturn without any decision being taken, since tax collections fall and welfare payments rise, and that is a feature of a well designed fiscal system rather than a failure of one. And borrowing to finance long lived capital assets spreads their cost across the generations that will use them, which is both fair and economically sensible. The case against a deficit is that government borrowing may crowd out private investment and raise interest rates; that the resulting debt generates an interest bill which pre empts future expenditure, as India's does at 14,03,972 crore rupees or about a quarter of the Union's total spending; that if it is monetised it is inflationary; and that if it finances consumption it is unfair between generations. The honest conclusion is that the composition of a deficit matters more than its size, which is precisely why the Budget reports four deficits rather than one.

6. What is the difference between a deficit and public debt, and when is debt sustainable? A deficit is a flow measured over a year, being the amount the Government must borrow in that year; public debt is a stock measured at a point in time, being the accumulation of all past borrowing not yet repaid. Each year's fiscal deficit adds to the stock, and the enlarged stock raises the interest payable in every subsequent year, so a deficit today mechanically increases expenditure tomorrow without any further decision being taken. Sustainability is judged not by the rupee amount of the debt but by its ratio to gross domestic product, because debt is serviced out of a growing economy's income. The arithmetic is that if the nominal growth rate of the economy exceeds the average rate of interest paid on the debt, the ratio of debt to gross domestic product falls even though borrowing continues, provided the primary deficit is contained; if the rate of interest exceeds the growth rate, the ratio rises unless the Government runs a primary surplus. It follows that the primary deficit, and not the headline fiscal deficit, is the variable that determines whether a debt path is stable.