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DeficitFinancingGeneralKnowledgeToday

Deficitreferstothedifferencebetweenexpenditureandreceipts.Inpublicfinance,itmeansthegovernmentisspending
more than what it is earning. Government expenditure and revenue can be split into capital and revenue. Capital
expenditure generally includes those expenses which result in creation of assets. Revenue expenditure is primarily that
whichdoesnotresultinassetcreationforexampleinterestpayments,salaries,subsidies,etc.Similarly,onthereceipts
side,whateverthegovernmentreceivesastaxesisrevenuereceipt.Receiptsnotofarecurringnaturearegenerallycapital
receipts. These include domestic and external borrowings, proceeds of disinvestment, recovery of loans given by the
Uniongovernment,etc.
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Deficitfinancingisanecessaryevil
Deficit financing is a necessary evil in a welfare state as the states often fail to generate tax revenue which is sufficient
enoughtotakecareoftheexpensesofthestate.Deficitfinancingallowsthestatetoundertakeactivitieswhich,otherwise,
wouldbebeyonditsfinancialcapacity.TheconceptwaspopularisedbynotedBritisheconomistJMKeyneswiththeaim
ofpumpingadepressedeconomy.

ProblemsofDeficitFinancing
Thebasicintentionbehinddeficitfinancingistoprovidethenecessaryimpetustoeconomicgrowthbyartificialmeans.
However, deficit financing helps to a certain extent only and beyond that it may cause havoc. Here are some of the
problemsofdeficitfinancing.

DeficitFinancingLeadstoinflation
Deficit financing may lead to inflation. Due to deficit financing money supply increases & the purchasing power of the
peoplealsoincreasewhichincreasestheaggregatedemandandthepricesalsoincreases.

Adverseeffectonsaving
Deficitfinancingleadstoinflationandinflationaffectsthehabitofvoluntarysavingadversely.Infectitisnotpossiblefor
thepeopletomaintainthepreviousrateofsavinginthestateofrisingprices.

AdverseeffectonInvestment
Deficit financing effects investment adversely when there is inflation in the economy trade unions make demand for
higherwagesforthattheygoforstrikesandlockoutswhichdecreasestheefficiencyofLabourandcreatesuncertaintyin
thebusinesswhichadecreasesthelevelofinvestmentofthecountry.

Inequality
In case of deficit financing income distribution becomes unequal. During deficit financing deflationary pressure can be
seenontheeconomywhichmaketherichricherandthepoor,poorer.Thefixwageearnersarebadlyeffectedandtheir
standardoflivingdeterioratesthusnogapb/wrich&poorincreases.

Problemofbalanceofpayment
Deficit financing leads to inflation. A high price level as compared to other countries will make the exports more
expensive and thus they start declining. On the other hand rise in domestic income and price may encourage people to
importmorecommoditiesfromabroad.Thiswillcreateadeficitinbalanceofpaymentandthebalanceofpaymentwill
becomeunfavourable.

Increaseinthecostofproduction
When deficit financing leads to the rise in the price level the cost of development projects also rises this means a larger
doseofdeficitfinancingisrequiredontheportofgovernmentforcompletionoftheseprojects.

Changeinthepatternofinvestment
Deficitfinancingleadstoinflation.Duringinflationpricesriseandreachtoaveryhighlevelinthatcasepeopleinstead
ofindulgingintoproductiveactivitiestheystartdoingspeculativeactivities.

IndiaandDeficitFinancing:
Indiaresortedtodeficitfinancing,thenlargelyfinancedthroughReserveBanksbookseitherbyprintingmoremoneyor
useofitsforeignexchangereserves,rightfromtheearlyyearsofplannedeconomicdevelopment.However,ourplanners
did not factor in the impact of deficit financing on inflation. But with large foreign exchange reserves, they were
confidentofthegovernmentsabilitytomanagethesupplysideoftheeconomy.
For much of the 1950s, the Bank was part of this consensus. Although the impact of deficit financing on prices had
arousedconcernalreadyin195152,pricestabilitydidnotreturnasamajorcauseofworryattheBankuntilthemid50
s.Besides,theBankrecognisedtheneedforanyplantogobeyondwhatavailableresourcesdictated,evenifsomepartof
theadditionalinvestmenthadtobefinancedthroughadditionstomoneysupply.

Isdeficitfinancinginevitable?
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DeficitFinancingGeneralKnowledgeToday

Deficitfinancingisneithergoodnorbad.itdependsuponthecircumstancesinwhichitisresortedtoandtheeconomic
policy which is followed to neutralize its adverse consequences. A certain measure of deficit financing is inevitable in
India under the planned economic development as one of the objectives of the planning is to step up the tempo of the
economic progress beyond what it would have been in absence of planning. As far as deficit financing does not lead to
inflation , there is no objection to its use. However , unfortunately, extent to which India has been practicing deficit
financinghasgonewaybeyondwhatcouldpossiblyhavebeencontemplatedbyLordKeynes.

RelationofDeficitFinancingandInflation
Deficit financing may not necessarily be inflationary there are certain conditions under which deficit financing may not
lead to inflation. With increase in money supply due to deficit financing prices do rise but rise in price will only be
temporary for about a period. As flow of goods and services increase prices will began to fall. deficit financing is an
important device for financing development plans for underdeveloped countries and accelerate their rate of economic
development.ButIfdeficitfinancingisnotkeptwithinlimitsItmaygiverisetoprices,distortedinvestmentandunequal
and unjust distribution of income. therefore it is essential that deficit financing is kept within limits and its impact on
pricesandcostsaresoftenedthroughvariouscontrols.

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