Risks for businesses and households: what does the idea of reducing the budget deficit mean?

On the fiscal consolidation proposed for Ukraine and its impact on the economy (IMF requirements – Ed.).

Usually, the discussion of macroeconomics is reduced to two indicators: the state budget deficit and the current account balance (conditionally, "are we in the black or white in front of the outside world").

However, this "two-sector optics" has a problem. It does not see the "third player" – the private sector within the country: households and businesses.

Historically, it was the accumulation of imbalances in the private sector (overheating of credit, accumulation of household and corporate debt) that was at the root of economic and financial crises. Therefore, it is extremely dangerous to ignore it .

Discussion of the state budget – and fiscal consolidation is a set of measures aimed at reducing the budget deficit – usually sounds like this: "we need to reduce the deficit", "we need fiscal consolidation", "we need to tighten fiscal policy".

But if the state begins to take more out of the economy than it "puts in", then this money should be withdrawn either from the private sector or from the external sector. That is:

- or the amount of funds from the private sector falls;

- or the country is running an increasing "external surplus," meaning that the inflow of resources from outside is growing, which is what is happening in Ukraine at the expense of international financial assistance, which is why we have a large surplus in the financial account of the balance of payments. The downside is the growth of public debt.

In other words, fiscal consolidation means a tighter budget. A tighter budget means a drop in private sector savings. And this is not only an increase in its vulnerability and a decrease in its ability to invest.

Translated from economic to human language, "reducing the budget deficit" without any reservations often means "shifting the deficit to businesses and households.".

This is especially critical for countries that are trying to grow through investment and lending. This is even more critical for countries where investment is severely lacking, as it is in Ukraine (primarily due to the war, but also for a number of other reasons).

A tighter fiscal policy in such a situation may not "improve the economy" but, on the contrary, knock out the already shaky support of business at a time when it needs a positive financial balance most.

In the context of the above, it is necessary to reiterate the vital importance of international financial assistance. Given the large and chronic deficit of the foreign trade balance (for example, this year Ukraine's imports exceed exports almost twice), if the flow of funds in the form of international financial assistance weakens (and it will), the economic system will be forced to "rebalance".

Either the budget will go deeper into deficit, or the private sector will start to "eat itself up".

So, two questions (the first is rhetorical, the second is interesting):

- how this will affect Ukraine's already weak economy?

- Who will bear the brunt of the impact – the state or the private sector?

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