How the govt can borrow more than 25% of what it spends

The finance minister's budget speech had just come to an end.

She was stretching herself on the sofa. "For an interim budget, this was quite a long speech," she said.

"Yes. But it wasn't soporific, like the last five budget speeches," I replied.

"Ha, ha," she replied. "Don't be mean."

"Just telling you the truth."

"But doesn't seem like the government is borrowing much this year or next."

"What makes you say that?" I asked.

"Oh, the fiscal deficit is just 3.4% of the gross domestic product (GDP)."

"And what is fiscal deficit?"

"V, I spend a lot of time with you," she smiled. "You don't think I would know this."

"Do you?"

"Fiscal deficit is the difference between what a government earns and what it spends."

"And how does it make up for the difference?"

"The government borrows."

"Yes."

"Hah. Don't sulk just because I knew it."

"Why did you say that government isn't borrowing much?" I asked.

"Because fiscal deficit is 3.4% of the GDP."

"Hmmm. Do you know how much that amounts to in absolute numbers?"

"Nah," she said. "Tell me."

"For this financial year it amounts to Rs 6,34,398 crore."

"Oh, that's a lot of money."

"The interesting thing is that the total expenditure of the government is Rs 24,57,235 crore. The fiscal deficit is forecast at Rs 6,34,398 crore."

"Hmmm. So, the fiscal deficit amounts to 25.8% of the government expenditure. And that is the amount the government borrows," she said.

"Yes."

"So, the government borrows a little more than one-fourth of the money that it spends."

"Yes, that's right," I replied.

"Now that I have looked at the situation from this angle, it seems totally different," she said.

"Yes, it does," I replied.

"It's just that it sounds so much less when expressed as a percentage of GDP."

"Hmmm. The GDP for 2018-2019 is forecast to be Rs 18,84,731 crore. Hence, fiscal deficit as a percentage of GDP works out to 3.4%."

"So, tell me something V, how is the government able to borrow so much money, more than 25% of what it spends."

"There are three rights that make any government a government."

"And which are?"

"The right to legal violence. The right to tax. And the right to create money out of thin air."

"Hmmm."

"Which basically means that governments have the right to print money."

"Which you and I don't," she said.

"Well, if we were to try anything of that sort, we would end up in jail."

"Yes."

"So, if worse comes to worst, the government can print money and repay the money it has borrowed over the years."

"Yes, that makes sense."

"And which is where you and I can learn a few lessons of borrowing."

"Like what?"

"The government can keep borrowing perpetually because the assumption is, it will always be around."

"Which is not the case with you and I."

"Exactly. Hence, you and I, have to repay what we borrow and cannot keep borrowing endlessly."

"Yes."

"Second, we cannot go overboard with our borrowing because we need to repay our borrowings out of our earnings, and unlike the government can't simply print money and repay it," I said.

"Yes. And that too."

"Also, given that the risk of lending to us as individuals is higher for banks, they charge us a higher rate of interest than they do to the government."

"That makes sense."

"The rate of interest at which banks lend to the government, becomes a benchmark for all other kinds of lending."

"Hmmm."

"Also, one last one point."

"Which is what?" she asked.

"Banks need to invest 19.25% of the deposits that they raise in government bonds, which are bonds issued by the government to borrow money in order to finance the fiscal deficit. This is mandatory. Through this, there is constant demand for government bonds, and the government is able to in a way control the interest that it pays on these bonds."

"That's interesting," she said. "I am done with learning for today."

"Let's order pizza."

The example is hypothetical.

(Vivek Kaul is the author of the Easy Money trilogy)