Understanding Primary Deficit: Formula, Calculations, and Implications Explained
Last Updated : Oct. 18, 2023, 12:08 p.m.
A primary deficit is a concept that aids in understanding the government’s financial conditions, burdens of debts, economic stability and so on. It also sheds light on how the government is managing the interest payments and if they are improving their financial conditions. An increase in primary deficit can have a bad influence on a country’s economy. Learn what is primary deficit, and how we can calculate it to understand the union budget.
What is a Primary Deficit?
Primary deficit refers to the amount of money that the government requires to meet the expenditure of the current year. It means the government requires the amount for the total expenditure against its total income. The primary deficit can be depicted by the difference between the fiscal deficit and the interest paid in the previous year by the government. However, a fiscal deficit refers to the government’s total expense subtracted from the total income.
In other words, the primary deficit can be determined by the maximum amount of government’s borrowing without involving interest payments. It indicates the spending of the government is more than the taxes or other sources, which excludes the interest payments on debts. It can result in increased debts on interest payments that can have a significantly bad impact on the country’s economic state and stability.
Reasons for Government’s Borrowing
There are numerous purposes governments need to borrow a huge amount of money. The following constitutes the need for the government’s borrowing.
- Public investment
- Capital transfer payments
- To purchase goods and services for public consumption
- National Defense
- Health and welfare benefits of the public
- The infrastructure of the country
- Income transfer payments le social benefits or pensions
Formula of Primary Deficit
The primary deficit can be calculated by the formula
Primary Deficit=Fiscal Deficit-Interest Payments
Where Fiscal Deficit can be calculated by
Fiscal Deficit=Total Income-Total Expenditure of the government
We can also calculate the primary deficit using the following formula
Primary Deficit=Total Revenue Earned-Expenses Incurred (excluding interest)
Calculations of Primary Deficit
Suppose in 2022, the government has earned revenue of INR 50 million. The incurred expense, including the interest payments, is INR 53 million. However, the interest payments are INR 2 million.
We first will calculate the Fiscal deficit using the formula
Fiscal Deficit=Total Income-Total Expenditure of the government
Total income is the revenue earned by the government = INR 50 million
Expenditure incurred = INR 53 million
Fiscal Deficit=INR (50-53)=INR 3 million
Now, for the primary deficit, we have to exclude the interest payment from the above calculation. Therefore, using the formula
Primary Deficit=Fiscal Deficit-Interest Payments
Primary Deficit =INR (3-2)=INR 1 million
It shows that the government is paying INR 1 million interest on the debts on previous year’s borrowed amount (2022).
Implications of Primary Deficit
The primary deficit portrays how interest payments can influence the government’s revenue. Interest payments can easily be determined by comparing fiscal deficit and primary deficit. We can also evaluate the size of the government’s borrowing or if the government relies on borrowing to meet the expenses for definite purposes.
If we notice a huge difference between the two deficits, it indicates that the government has borrowed a huge amount the previous year, which is eating its revenue for the current year. In case the difference between the two deficits is low, it determines that the government has borrowed a limited amount.
If you see the primary deficit as zero, it determines that the government is taking a loan to pay the previous year’s interest. It depicts that the debt strain on the government for the prior year is extreme. To fulfil the same, the government has to borrow the amount as they lack sufficient funds.
Moreover, if there is a decrease in the primary deficit, it indicates that there is progress in fiscal health. Keep note that deficit is taken in the form of a percentage of GDP, i.e., Gross Domestic Product. It is needed to achieve a true perspective and simplify comparison.
Measures to Stabilise the Primary Deficit
There are certain measures through which the government can rectify the primary deficit, including
By Decreasing the Expenses
Reduction in the expenditure by the Government is directly proportional to the reduction in fiscal deficit, which automatically reduces the primary deficit.
Increasing the Revenue
If there is a rise in revenue, it results in the reduction of fiscal deficit, enabling the government not to borrow the amount for expenses and to have sufficient funds. Furthermore, it automatically reduces the interest payments, which corrects the primary deficit.
Difference Between Primary Deficit and Fiscal Deficit
Here is the difference between the primary deficit and fiscal deficit in tabular form.
| Characteristics | Primary Deficit | Fiscal Deficit |
|---|---|---|
| Definition | Primary deficit is fiscal deficit minus interest payments. | When we take the difference between total revenue and total expenses by the government, along with the interest payments, it is called fiscal deficit |
| Expression | Fiscal deficit - Interest Or Total revenue - Total expense - Interest | Total revenue - Total expenditure |
| Implication | Portrays the deficit caused, excluding interest on previous loans. | Showcase the requirement of borrowing based on the expenses. |
Conclusion
Primary deficit is an important component in analysing the country’s economic state. If you know what is a primary deficit, then you can easily evaluate the pressure of debts on previous loans borrowed by the government to meet the country’s expenses. The government generally takes additional funds to pay the interest. If the deficit is reduced, it determines the financial health of the government is improving. Each year, when the Union budget is passed, there is information on primary and fiscal deficits represented in the form of percentages to identify the financial condition of the government.
Frequently Asked Questions
1. What is a Revenue deficit?
A revenue deficit is defined as the deficit between the revenue expenditure and the revenue receipt. It means the indication of excess of total expenditure generated over the total revenue receipt. The formula can calculate it: revenue receipts – revenue expenditure.
2. State the difference between the implications of revenue deficit and primary deficit.
A revenue deficit implies that the borrowing of the government is required to meet the daily expenses. In contrast, the primary deficit showcases the deficit caused without including the interest payments on prior loans.
3. Define the implication of Fiscal deficit.
A fiscal deficit portrays that borrowing from the government is required to meet the aggregate expenditure.