Introduction: face foreign exchange crises. In brief the broad

Introduction:

In every economy whether it is two, three or four sector,
functional equality exist between income and expenditure. It is stated by
Keynes as aggregate demand and aggregate supply equality. Mathematically it is
sated by the following equation.

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Y= C+I+G+X-M

Y= C+S+T

C+I+G+X-M=Y=C+S+T

(X-M) = (S-I) – (G-T)

(X-M) represents net of export which can be positive or
negative and (G-T) represents budget deficit or surplus.  Important indictors to represents deficit in
the budget is Fiscal deficit. Similarly important indicator to represent net of
export is current account deficit.

Back Ground:

The above mathematical equation represents mathematical relationship
between net of exports and deficits in the budget. It is also possible that
functional relationship may exist between net of export and budget deficit.

Fiscal deficit represents resource gap of the union
government. After great depression of 1929, all countries started adopting
Keynesian economics macroeconomic policy. Keynes advocated deficit budget hence
all economies including India adopted deficit budget strategy for fiscal
management of the economy. Deficit budget could bring good economic growth. The
deficit in the budget started growing.

Developed part of the world realized the danger of growing
fiscal deficit. If fiscal deficit is not controlled it can result in high
inflation, which is very dangerous to an economy. High inflation will reduce
the value of currency of a country which can shake the people’s faith in
currency which is further more dangerous. Investment climate in the economy
will not be good for promoting investment which will have adverse impact on
economic growth.  It will also have
adverse impact on balance of payment of the country. Economies having high
fiscal deficit can face foreign exchange crises. In brief the broad objectives
of fiscal policy such as full employment, price stability, and rapid economic
growth can’t be achieved with high fiscal deficit .

Keeping all these factors in mind European economies and
U.S.A decided to move from discretionary fiscal policy to rule based fiscal
policy. They made legislation like FRBM in India so that government is force to
keep deficit under controlled in 1980s. Once developed economies make changes
in their policies and procedures they expect developing economies to follow
their footsteps. If developing countries do not listen to them, they will
create situations and wait for an opportunity so that developing economies will
have no choice than to follow them.

With regards to India’s fiscal deficit, it was growing from
1970. Post 1980 the fiscal deficit growth got further accelerated. In the year
1986-1987 it was at the pick of 8.4. The revenue deficit was also following the
same pattern. India faced unprecedented foreign exchange crises mainly due to
sharp rise in the prices of crude oil following the gulf war. Due to sharp rise
in the in oil price the import bill of the country shot up from monthly average
of $287 million in June- August 1991 to $671 million in the following six
months. As a result the foreign exchange reserve decline from $3.11 billion in
August 1990 to $896 million in January 1991¹. The Indian economy was on the verge
of economic collapse. However the financial help provide by the IMF in the form
of a loan of $665 million in September 1990 helped the country to tide over the
crises. This crises conditions and need for evaluating the significance and
relevance of country’s economic policies in general and fiscal policy and foreign
trade policy in particular. The new government undertook a review of
export import policy of 1990-1993 and introduced major reforms on 4th
July, 1991aimed at vigorous elimination and reduction of import licensing,
export promotion and optimal import saving

India adopted the liberalization policy. The process of
liberalization started when Dr. Manmohan Singh then finance minister presented
the epoch making budget on July24, 1991 after foreign exchange crises of
1990-1991. The budget speech of the Finance minister also refers to fiscal
discipline to be maintained by the government. Finance minister said in his
budget speech that “The crisis of the fiscal system is a cause for serious
concern. The fiscal deficit of the Central Government, which measures the difference
between revenue receipts and total expenditure, is estimated at more than 8 per
cent of GDP in 1990-91, as compared with 6 per cent at the beginning of the
1980s and 4 per cent in the mid-1970s. This fiscal deficit had to be met by
borrowing. As a result, internal public debt of the Central Government has
accumulated to about 55 per cent of Gross Domestic Product (GDP). The burden of
servicing this debt has now become onerous. Interest payments alone are about 4
per cent of GDP and constitute almost 20 per cent of the total expenditure of
the Central Government. Without decisive action now, the situation will move
beyond the possibility of corrective action.” In short fiscal discipline is on
the top of government agenda. Subsequently in the year 2003 FRBM act was passed
by the parliament which makes it obligatory to government to reduce fiscal
deficit to 3% of GDP in five years time along with other provisions of the
bill.

High fiscal deficit leads to inflation which will reduce
export and increase import, as imported commodities are cheaper making
unfavourable balance of payment.  It
means negative current account balance will increase. In short there exist
inverse relationship between fiscal deficit and current account balance.

Objective of the Research:

1)     
To study the relationship between current
account deficit and Fiscal deficit from 1970 to 2016-2107.

2)     
To study the relationship between current
account deficit and Fiscal deficit pre liberalization.

3)     
To study the relationship between current
account deficit and Fiscal deficit post liberalization.

Definition of important concepts:

 Fiscal deficit= Total
Budget expenditure (Revenue expenditures + capital expenditures) les Tax
revenue less recoveries of loans less other receipts mainly (PSU disinvestment)

Current account deficit= Trade balance + Net invisibles.
Trade balance= Exports of goods – imports of goods.

Research Methodology:

The secondary time series data is used
which is collected from Reserve Bank of India’s publications from time to time.
The data is collected from 1970-1971 to 2016-2017. Fiscal deficit as percentage
of GDP is considered representing fiscal deficit.  The Current account deficit as percentage of
GDP is considered to represent current account deficit. Fiscal deficit is
considered to be controlled variable as it can be monitored and controlled by
the Government through Fiscal policy measures such as union budget and budget
outcome. Current account deficit is considered to be independent variable as it
cannot be controlled by the Government through export import policy alone.
Current account deficit is influence by several factors such as crude oil
prices, exchange rate, economic and political environment of countries with which
we have tread etc are outside the economy and hence cannot be monitored or
controlled through domestic policies.

Regression analysis is used for the purpose
of data analysis. The data analysis is made for the period 1970-1971 to
2016-2017. The data is also analyzed for pre and post liberalization period, i.e.
1970-1971 to 1990-1991 and 1991-1992 to 2.16-2017.

Formulation of the model:

Current account deficit = f (fiscal
deficit)

F0: There is no relationship between fiscal
deficit and current account deficit for a period 1970 to 2017.

F1: The relationship between fiscal deficit
and current account deficit is inverse.

F01: There is no relationship between
fiscal deficit and current account deficit for a period 1970 to 1991. This is a
pre liberalization period.

F11: The relationship between fiscal
deficit and current account deficit is inverse.

F02: There is no relationship between
fiscal deficit and current account deficit for a period 1991 to 2017. This is
post liberalization period.

F12: The relationship between fiscal
deficit and current account deficit is inverse.

 

Data Analysis:

Interpretation of the regression result for
the period 1970-1971 to 2016-2017:

The estimated function is as follows.

               Y = 0.578129 – 0.33815X

               Fiscal deficit and current
account deficit are inversely related. If fiscal deficit rises by one     percentage point, negative current account
deficit will decline by 0.338 percentage point.  As’t’ value is greater than 2, the estimated coefficient
is significant at 0.05 level. Since the value of R² is 0.147197, fiscal deficit
is capturing 15% change in current account deficit. The calculated F value is
greater than table value, the equation is statistically significant. As the P
value is less than 0.05 null hypothesis is rejected.

Interpretation of the regression result for
the period 1970-1971 to 1990-1991 (pre liberalization period):

The estimated function is as follows.

               Y = 1.622868 – 0.49627X

               Fiscal deficit and current
account deficit are inversely related. If fiscal deficit rises by one     percentage point, negative current account
deficit will decline by 0.49627 Percentage point. As’t’ value is greater than
2, the estimated coefficient is significant at 0.05 level. Since the value of
R² is 0.553253, fiscal deficit is capturing 55% change in current account
deficit. The calculated F value is greater than table value, the equation is
statistically significant. As the P value is less than 0.05 null hypotheses is
rejected.

Interpretation of the regression result for
the period 1991-1992 to 2016-2017(post liberalization):

The estimated function is as follows.

               Y =0.93784- -0.06422X

               Fiscal deficit and current
account deficit are inversely related. If fiscal deficit rises by one     percentage point, negative current account
deficit will decline by 0.06422 percentage point. As’t’ value is greater than
2, the estimated coefficient is significant at 0.05 level. Since the value of
R² is 0.002749, fiscal deficit is capturing 3% change in current account
deficit. The calculated F value is greater than table value, the equation is
statistically significant. As the P value is greater than 0.05 null hypotheses
is accepted.

Conclusion:

High fiscal deficit is responsible for
growing negative current account deficit. During pre liberalization period as
per data analysis 55 percentage changes in the current account deficit was
responsible for growing current account deficit. Economic theory holds true for
Indian scenario also. Through policy initiatives taken by the government of
India to keep deficit under control not only maintain fiscal prudence or
discipline but is also successful in keeping current account deficit under
control. The conclusion validates the policy stance of the government.

Limitations of the Research:

There are several factors impacting
current account deficit. Some of them can be inflation, exchange rate, trade policy
of the countries with which India is having major trade and many more. In this
study one factor fiscal deficit is studied. This study does not factor other
major factors such as 1972 and kargil war, 1972 drought, 2008 recession ect.  which might have played an important role in
influencing current account deficit.

Scope for further research:

Other major factors such as exchange
rate, inflation rate, interest rate etc. can be incorporated in the model. Such
study will help in macroeconomic policy formulation related to foreign trade
and other such related policies.