Large and persistent fiscal deficit threatens the government’s debt sustainability. The growing interest burden eats into the resources available for discretionary expenditure. Importantly, it crowds out the private sector from the debt market, inhibits private investment and affects future production capacity. Fiscal deficit can also spill over and trigger balance of payments pressures as indeed happened in India in 1991. 63.
By far the biggest concern stemming from a large fiscal deficit, especially from the Reserve Bank’s perspective, is that it adds to aggregate demand and thereby to inflation pressures. By crowding out the private sector, fiscal deficit could also inhibit, if not impair, monetary policy transmission to the private sector.