What is a twin deficit problem?

The Russian invasion of Ukraine entered its 119th day on Wednesday. The epicentres of the war are in tatters, and casualties mounting. But beyond the borders of the region, countries are engaged in a different kind of war. A war to save their economies.

Crude oil prices are hovering above $100 a barrel for a while, supply chain is disrupted, inflation in most countries is above their comfort level and the world’s largest economy, the US, is staring at recession. India too couldn’t remain untouched.

The country’s finance ministry — in its recent ‘Monthly Economic Review’– has struck a note of caution on the twin deficit problem. Which is an increase in both fiscal deficit and current account deficit at the same time. But before we explain what it could mean for the economy, let us have a brief look at these two deficits.

In simple terms, fiscal deficit is a scenario where the government spends more money than the revenue it gets. The government fills this void by borrowing — mostly from the markets.

A current account deficit is the shortfall between the money received by selling products to other countries and the money spent to buy goods and services from other nations.

So what happens when the twin deficit problem strikes? And why we may be staring at it. The Ukraine war has led to the supply shortages, leading to higher commodity prices and increased subsidy burden on the government. Adding to that, the duty cuts on petrol and diesel mean the government may have to forgo Rs 85,000 crore in revenue for the current fiscal. As the war lingers, there is every chance the government may miss the fiscal deficit target for FY23. Which is 6.9 percent of GDP.

The increase in the fiscal deficit may cause the current account deficit to widen. The twin deficit problem, especially the worsening current account deficit, may compound the effect of costlier imports, and weaken the value of the rupee thereby further aggravating external imbalances. This creates the risk — even though admittedly low at this point of time — of a cycle of wider deficits and a weaker currency.

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