What are the twin deficits?

by Manshu on February 20, 2013

in Economy

With the budget looming close, the reference to India’s twin deficits have increased even more than usual, and I thought I’d do a quick post on them.

When someone refers to India’s twin deficits, they are referring to the following two things:

  • Current Account Deficit
  • Fiscal Deficit

Current Account Deficit: I have done a fairly detailed post on current account deficit (Read: What is BoP and Current Account Deficit?) so I will keep this definition brief. Current account deficit is the difference between a country’s exports and imports, and when imports exceed exports, a country is said to be running a deficit on its current account.

Oil and gold are India’s two big imports, and the last budget saw the duty on gold being raised from 2% to 4% in order to slow down gold imports and ease the current account deficit. This hardly helped, and India will have a current account deficit again. Any measures in the budget to slow down imports or boost exports will help the current account deficit.

Fiscal Deficit: Fiscal deficit is the difference between the revenues and expenses of the government that they have to cover by engaging in borrowing from the market.

This covers everything and is not restricted to imports or exports. Any measures to reduce spending, or generate additional tax revenues or other revenues like disinvestment are aimed to bring the fiscal deficit under control. (Read: What is fiscal deficit?)

Why are these two a problem?

Why do we hear so much about these two deficits, and why are they a problem?

A lot of countries run these deficits and having these deficits is not a problem on its own. It is the magnitude that’s the problem. In the last budget, the government borrowing constituted about 35% of their total revenues. This means that the government had to raise money even to pay for their recurring expenses, and that’s never a good thing.

Imports exceeding exports perennially can become a problem because the country has to part with foreign exchange with which it pays for these exports and in India’s case, the forex hasn’t been a problem in recent years because of capital inflows like FII money, but you can’t rely on them all the time.

Together they weaken the country’s financial position, and let’s hope to see some good measures on easing the burden on them in this budget.

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{ 6 comments… read them below or add one }

sunil February 20, 2013 at 12:07 pm

A nice post to understand for any layman….

The magnitude is widening day by day…. hope to see more disinvestments and more policy reforms.

Above all .. No Scam India can give us more revenue than any policy reforms could evr give…. Alas! that will never happen.

sunil.

Reply

Manshu February 20, 2013 at 5:44 pm

No scams are reforms of the highest order.

Reply

ramamurthy February 20, 2013 at 2:27 pm

Questions please?
1.You can import only to the extent of your exports.You cannot import if you do not have exports.So,how can there be a deficit or surplus?
2.Should not current account deficit/surplus always match with Capital account surplus/deficit?If not what is the solution?In domestic economy the Govt can print notes what ever may be the future consequences.This option is not available in case of foreign currency.

Reply

Manshu February 20, 2013 at 5:41 pm

1. No, that’s not true. How much you import is not dictated by your exports. It is dictated by how much foreign reserve you have.
2. Yes, the current account and capital account should net to zero. India has been running a capital account surplus but that still means it owes money to foreigners either in terms of stake in companies or debt issues.

In case of foreign currency, the country has to borrow in USD or JPY or EUR from bodies like IMF. Very similar to what India had to do in the early 90s by pledging gold with IMF and getting borrowings in return of opening up the economy.

Reply

ramamurthy February 27, 2013 at 1:47 pm

1.But the Foreign reserve is built only if the exports are higher than imports or there is a surplus in the Capital Account.
2.So in total scenario there cannot be a deficit or surplus situation.

Reply

Manshu March 4, 2013 at 5:16 am

1. That’s correct.
2. By total you mean over a number of years? Yes, and no, because there can be a Greece like or Argentina like situation where creditors are forced to write off debts.

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