Primary Deficit Formula

[Millicent]

Ashrinking primary deficit shows progress towards fiscal health. The Budget document also suggests a deficit as a percentage of GDP. This is to promote comparison and get a proper perspective. Prudent fiscal management demands that the government does not borrow to consume in the ordinary course.

The primary deficit is calculated by subtracting interest payments for the borrowings from the current year's fiscal deficit. The fiscal deficit is calculated by determining the difference between the total income and total expenditure of the government.

Primary deficit= Total revenue - Total expenditure excluding interest payments on its debt.Primary deficit = Fiscal deficit - Interest payment.The interest payment will be the payment that a government makes on borrowings to the creditors.

This indirectly indicates the size of the borrowings and shows whether the Government depends on borrowings to meet its expenses. A major difference between the two deficit figures shows that the Government has borrowed a considerable amount of money which is eating into its revenue. On the other hand, a low difference shows limited borrowings.

If the primary deficit is zero, it means that the Government is borrowing only to meet the interest payable on previous loans. This means that the strain of the previous borrowings is high and is forcing the Government to borrow more.

Alternatively, if the Government increases its revenue, the fiscal deficit falls. This also causes the primary deficit to fall as the Government gets sufficient funds to meet its expenses without having to borrow. As borrowings are reduced, the interest payment on the same is also reduced, and the primary deficit can be corrected.

A reduction in the primary deficit indicates progress towards fiscal health. In addition, the deficit is expressed as a percentage of GDP. It is required in order to gain a proper perspective and facilitate comparison.

However, it is important to note that even with a zero primary deficit, a government may still have an overall budget deficit if it is required to make significant interest payments on its existing debt. In this case, the government would still need to borrow funds to cover those payments and would be adding to its overall debt burden.

The debt stabilising primary deficit (DSPD) is the level of the primary (i.e. non-interest) deficit at which debt would stay constant as a share of GDP.a It must be large enough to offset the effects of: (i) the growth rate of nominal GDP, which lowers debt relative to GDP, and so raises the DSPD; (ii) the nominal interest rate on government debt, which has the opposite effect; and (iii) any stock-flow adjustments (factors other than borrowing that affect debt), like loans and asset sales, which can have either a positive or negative effect.

Primary deficit is referred to as the difference that exists between the fiscal deficit of the current year and the interest payment that was needed to be paid in the previous fiscal year. It is one of the three important measures of determining the government deficit.

It shows the requirement of borrowing of the government and excludes any kind of interest. It also highlights the amount of government expenses that needs to be met through borrowing other than the interest payment.

A decrease in the primary deficit reflects the improvement in the fiscal health of the economy, when the primary deficit becomes zero, it suggests that the government only needs to borrow only to pay off the interest payments due from the previous year.

The government budget balance can be broken down into the primary balance and interest payments on accumulated government debt; the two together give the budget balance. Furthermore, the budget balance can be broken down into the structural balance (also known as cyclically-adjusted balance) and the cyclical component: the structural budget balance attempts to adjust for the impact of cyclical changes in real GDP, in order to indicate the longer-run budgetary situation.

The government budget surplus or deficit is a flow variable, since it is an amount per unit of time (typically, per year). Thus it is distinct from government debt, which is a stock variable since it is measured at a specific point in time. The cumulative flow of deficits equals the stock of debt when a government employs cash accounting (though not under accrual accounting).

The government fiscal balance is one of three major sectoral balances in the national economy, the others being the foreign sector and the private sector. The sum of the surpluses or deficits across these three sectors must be zero by definition. For example, if there is a foreign financial surplus (or capital surplus) because capital is imported (net) to fund the trade deficit, and there is also a private sector financial surplus due to household saving exceeding business investment, then by definition, there must exist a government budget deficit so all three net to zero. The government sector includes federal, state and local governments. For example, the U.S. government budget deficit in 2011 was approximately 10% GDP (8.6% GDP of which was federal), offsetting a capital surplus of 4% GDP and a private sector surplus of 6% GDP.[3]

Financial journalist Martin Wolf argued that sudden shifts in the private sector from deficit to surplus forced the government balance into deficit, and cited as example the U.S.: "The financial balance of the private sector shifted towards surplus by the almost unbelievable cumulative total of 11.2 per cent of gross domestic product between the third quarter of 2007 and the second quarter of 2009, which was when the financial deficit of US government (federal and state) reached its peak...No fiscal policy changes explain the collapse into massive fiscal deficit between 2007 and 2009, because there was none of any importance. The collapse is explained by the massive shift of the private sector from financial deficit into surplus or, in other words, from boom to bust."[3]

Economist Paul Krugman explained in December 2011 the causes of the sizable shift from private deficit to surplus: "This huge move into surplus reflects the end of the housing bubble, a sharp rise in household saving, and a slump in business investment due to lack of customers."[4]

The sectoral balances (also called sectoral financial balances) derive from the sectoral analysis framework for macroeconomic analysis of national economies developed by British economist Wynne Godley.[5]

GDP (Gross Domestic Product) is the value of all goods and services produced within a country during one year. GDP measures flows rather than stocks (example: the public deficit is a flow, measured per unit of time, while the government debt is a stock, an accumulation). GDP can be expressed equivalently in terms of production or the types of newly produced goods purchased, as per the National Accounting relationship between aggregate spending and income:

In any given time period, the government's budget can be either in deficit or in surplus. A deficit occurs when the government spends more than it taxes; and a surplus occurs when a government taxes more than it spends. Sectoral balances analysis shows that as a matter of accounting, government budget deficits add net financial assets to the private sector. This is because a budget deficit means that a government has deposited, over the course of some time range, more money and bonds into private holdings than it has removed in taxes. A budget surplus means the opposite: in total, the government has removed more money and bonds from private holdings via taxes than it has put back in via spending.

where NX is net exports. This implies that private net saving is only possible if the government runs budget deficits; alternately, the private sector is forced to dissave when the government runs a budget surplus.

According to the sectoral balances framework, budget surpluses offset net saving; in a time of high effective demand, this may lead to a private sector reliance on credit to finance consumption patterns. Hence, continual budget deficits are necessary for a growing economy that wants to avoid deflation. Therefore, budget surpluses are required only when the economy has excessive aggregate demand, and is in danger of inflation. If the government issues its own currency, MMT tells us that the level of taxation relative to government spending (the government's budget deficit or surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government's activities per se.

"Primary balance" is defined by the Organisation for Economic Co-operation and Development (OECD) as government net borrowing or net lending, excluding interest payments on consolidated government liabilities.[7]

The meaning of "deficit" differs from that of "debt", which is an accumulation of yearly deficits. Deficits occur when a government's expenditures exceed the revenue that it levies. The deficit can be measured with or without including the interest payments on the debt as expenditures.[8]

The primary deficit is defined as the difference between current government spending on goods and services and total current revenue from all types of taxes net of transfer payments. The total deficit (which is often called the fiscal deficit or just the 'deficit') is the primary deficit plus interest payments on the debt.[8]

That is, the debt after this year's government operations equals what it was a year earlier plus this year's total deficit, because the current deficit has to be financed by borrowing via the issuance of new bonds.

Economic trends can influence the growth or shrinkage of fiscal deficits in several ways. Increased levels of economic activity generally lead to higher tax revenues, while government expenditures often increase during economic downturns because of higher outlays for social insurance programs such as unemployment benefits. Changes in tax rates, tax enforcement policies, levels of social benefits, and other government policy decisions can also have major effects on public debt. For some countries, such as Norway, Russia, and members of the Organization of Petroleum Exporting Countries (OPEC), oil and gas receipts play a major role in public finances.

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