Twin Deficit

Indian and other developing country policymakers have shown interest in what is now referred to as the "Twin Deficit Problem." It is the coexistence of two fundamental economic gaps: the fiscal and the current account deficits. The two combined can pose a significant threat to the macroeconomic balance of a country.

What are these gaps, and what is their significance? Let us break down the idea further.

What is a Twin Deficit?

A country experiencing fiscal and current account deficits simultaneously is known as a Twin Deficit. To put it simply, a fiscal deficit occurs when a government spends more than it earns in revenue. A current account deficit occurs when a country is in a trade deficit with the rest of the world.

• Fiscal Deficit = Government's total expenditure − Total revenue (without borrowings)
• Current Account Deficit (CAD) = Value of imports − Value of exports + Net income + Net transfers

The Twin Deficit Hypothesis

The Twin Deficit hypothesis poses a considerable risk to any economy, as it reflects a nation’s susceptibility to both internal and external economic governance. Taking the Indian economy as an example, it demonstrates the need for controlled management of exports concerning the regulated government spending for a resilient economy, controlled spending, and reduced 

The Twin Deficit Hypothesis proposes a connection between an increase in fiscal deficit and the rise in current account deficit. Let’s break it down: reliance on imports. Given the global interdependence, addressing and managing the economic deficit strategically fosters growth and enhances investor confidence in the country.

• Larger fiscal deficits usually lead to an increase in the government’s borrowing.
• A rise in government spending leads to greater consumption.
• Greater demand for goods usually leads to a rise in imports.
• The current account deficit grows deeper when the country’s imports increase more than its exports.

The key features of the twin deficit are: 

 

Feature	Description
Interlinked deficits	A rise in the fiscal deficit often worsens the current account deficit
Demand-driven	Fiscal deficit-induced demand increases imports dependency
Currency impact	Higher CAD weakens the domestic currency, affecting inflation
Dependence on foreign capital	High CAD makes countries reliant on FDI and FII
Inflationary pressures	Twin deficits can lead to rising inflation, especially in developing nations.

 

Example: Twin Deficit in India

• For the fiscal year 2022-2023, India recorded the following:
• A current account CAD deficit greater than 2.5% of GDP.
• A fiscal deficit of over 6 percent of GDP.

The high CAD was the result of high oil imports, low export revenues, large government spending, a large CAD due to stimulus and subsidy spending, and elevated fiscal deficits.

Key Policy Challenges in Twin Deficit

A government with twin deficits must face the following.

• Loss of value in the country’s currency.
• Higher rates of inflation.
• Loss of confidence in the capital markets, both abroad and at home.
• Greater Challenges in attracting foreign capital.

For instance, a twin deficit economy where the CAD is falling while the current account deficit is swelling leads to an inflationary spiral, increasing the cost of subsidized imports.

Which Measures Should Be Taken By Governments To Address The Twin Deficit?

Reduce Fiscal Deficit: 

• Limit Spending
• Rationalize subsidies
• Expand the tax base

Improve currency account balance: 

• Limit wasteful spending
• Enhance the Current Account Balance
• Encourage exports via incentives
• Substitute domestic production for imports (like Atmanirbhar Bharat)
• Promote exports in the service sector (IT, tourism)

Monetary Policy

• Manage currency fluctuations
• Tackle inflation via interest rates

Structural Changes

• Ease of doing business
• Export-focused infrastructure
• Energy self-sufficiency to reduce dependence on oil imports

 

Did you know? Over the long term, twin deficits make economies vulnerable to external shocks, currency or debt crises like Greece in 2009 or Argentina.

Read More 

• Import Trade
• Environmental Economics 
• Corporate Social Responsibility 
• Net Domestic Product

Start preparing for your exams with our Commerce Articles for extra guidance!

Frequently Asked Questions (FAQs)

Is the Twin Deficit always bad?

Not always. During times of economic stagnation, moderate deficits can be helpful, but ultimately, large, persistent ones will foster a financial crisis, inflation, or both.

Why is the twin deficit concern relevant for India?

As a key importer of crude oil and many commodities, India is impacted by global price hikes, increasing both the fiscal and current account deficit when the government spends.

Is it possible to fix the twin deficit by only relying on exports?

Exports help, but we cannot solely depend on them. Ongoing management of twin deficits entails balancing trade and trade deficits alongside fiscal deficits, both requiring reduced imports and heightened self-reliance.

 

reliance on imports. Given the global interdependence, addressing and managing the economic deficit strategically fosters growth and enhances investor confidence in the country.