Not all deficits are equal

Not all deficits are equal
Not all deficits are equal

Example with India, the United States and France, where the deficits are of comparable magnitude, but their natures are very different.

Deficit issues attract a lot of attention, and rightly so. Their widening generally reveals significant imbalances or an uncertain future, most often accompanied by marked volatility in the interest rate and foreign exchange markets.

But, not all deficits are equal. Let’s look at the case of three countries located on three distinct continents: India, the United States and France. The deficits are of comparable magnitude1, but their natures are very different. The link between the budgetary deficit and the evolution of public debt varies according to the level of deficit from which the debt/GDP ratio deteriorates, but also the room for maneuver available to each State to change its trajectory.

Source: Carmignac, Bloomberg, IMF, April 2024

Let’s start by examining the latitude a government has to – if necessary – widen its deficit. For the three countries considered, whose debt-to-GDP ratio is relatively close (around 100%), the tolerable deficit level (i.e.: “the deficit level which does not degrade the debt ratio”) is a function of the rate growth in nominal GDP. In other words, the latter determines the upper deficit limit from which the debt/GDP ratio increases.

With strong potential growth, the denominator (the size of the economy) grows at a greater rate than the numerator (the amount and service of debt). And with real GDP growth expected at over 7% per year and inflation hovering around 4%, the next decade should be more beneficial to India than to France or the United States – whose Growth and inflation should be around 2% on average. Being a young country and catching up with the rest of the world certainly has its advantages.

To change the trajectory of the deficit, a State can use several levers: increase its revenues, reduce its expenditure, or do both at the same time.

Let us first examine the factors that contribute positively to budget balance. The tax revenues of States constitute a key determinant, through their capacity to raise taxes. Very often, these revenues are higher in the economies of developed countries than in those of emerging countries. However, in France, where taxes represent nearly 45% of GDP, we can doubt Bercy’s ability to identify additional sources of income. Theorized by the American economist Arthur Laffer, the eponymous curve reveals that from a certain level, any increase in the tax rate leads to a reduction in tax revenue – in other words, to use the former president’s formula of the French Republic Jacques Chirac, “too much tax kills tax”. On the other hand, the American and Indian governments have room for fiscal maneuver if this proves necessary.

If we now consider the margin for reducing expenditure available to a State. Two of the largest expenditure items, and potentially expected to grow further, of the governments mentioned above concern social transfers and interest charges. Expenditures relating to demographic aging in developed countries, growing demand for social benefits, decarbonization and rearmament appear irreversible. As for interest charges, which represent between 2.6% and 3.5% of GDP for each of the three countries considered, their future trajectories should diverge somewhat. Those of India should gradually decrease over the coming years, while they should, in the best case scenario, stabilize in the United States and France2.

In conclusion, as an Indian minister declared, “a country needs budgetary discipline to build a strong and socially just economy”3.

1 When we relate them to the size of each of these economies.
2 The IMF Public Finance Monitor announces a reduction in the interest charge from 1% to 2% of GDP for India by 2029, while it should remain at 3.4% of GDP across the Atlantic and increase to 2.8% of GDP in France.
3 Smriti Irani, Minister of the “Union Government” and Member of the “Lok Sabha”.



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