#EconomicSurvey: Fiscal Deficit Should Fall For Housing & Mortgage Markets To Function Better

While presenting the Economic Survey 2015-16 in Parliament today (February 26), Finance Minister Arun Jaitley said that the government would meet its fiscal deficit target of 3.9 per cent of the gross domestic product (GDP). Moody's Investor's Service, a leading rating agency, had recently said India's fiscal status was likely to remain dismal, even when compared to other emerging economies because state and the Centre had huge debts and high deficits. However, Jaitley said in his speech that the government was committed to fiscal consolidation, and that the target for the current year seemed achievable.

In the financial year 2014-15, Indian's fiscal deficit was 4.1 per cent of the GDP, but the government has set a fiscal deficit target of 3.9 per cent for the current financial year, and that of 3.5 per cent for the next financial year. Earlier, the government had set a fiscal deficit target of three per cent for the fiscal 2016-17. India's budget deficit had fallen from 6.5 per cent of the GDP in the fiscal year 2010 to 4.1 per cent of the GDP in the previous financial year.

The real link

The growth of the real estate industry requires a fall in India's fiscal deficit. Why? When the fiscal deficit rises, the gap between the government's earning and spending rises. In such a scenario, the government has primarily two ways of dealing with this. If the government finances the deficit by selling bonds to the general public, there will be a transfer of funds from people to the government. So, real estate investors and home buyers will have less to spend on houses and other real estate assets. It is, in fact, true that all forms of government spending involves a transfer of funds from people to the government. However, when the government sells bonds to the public, it is often their savings that people use to invest. As people tend to invest their savings in real estate and other forms of assets, this is especially likely to lower investment.

When there are less savings in the hands of the public, and when there is less investment, interest rates will also rise. This is because many borrowers compete for limited funds. As interest rates are determined by the supply of, and demand for funds, it is not surprising that interest rates rise when savings are channeled into government bonds.

However, this is not the only possibility.

The government is quite likely to finance the fiscal deficit by selling bonds to the banking system, that is, by increasing the money supply. When money supply increases, the new money that enters the economy will compete with the savings of people, lowering the value of the existing money in the economy. Prices will rise, and the value of real estate assets will rise, too. As prices and capital appreciation is high, interest rates will rise, too, making housing more expensive. So, regardless of whether the high fiscal deficit is funded by selling bonds to the public or by increasing the money supply, this will have a detrimental effect on the mortgage market and the housing market.

India's fiscal deficit has been high for long, and this partly explains why real interest rate in India in 2014 was seven per cent, while the United States had a real interest rate of 1.8 per cent.