DEFICIT FINANCING IN INDIA

CONTENTS-

SR. NO. TOPIC PAGE NO.

1 Deficit budget 3

2 Deficit financing 5

3 Objectives of deficit financing 6

4 Deficit financing sources 7

5 Adverse effects of deficit financing 8

6 Graphs 9

7 Is deficit financing inflationary? 9

DEFICIT BUDGET-

A deficit is the amount by which a sum falls short of some reference amount. When government expenditure exceeds government receipts in the budget is said to be a deficit budget.

In economics, a deficit is an excess of expenditures over revenue in a given time period. When a government spends more than it collects by way of revenue, it incurs a budget deficit. There are various measures that capture government deficit and they have their own implications for the economy.

REVENUE DEFICIT-Revenue deficit refers to the excess of government’s revenue expenditure over revenue receipts.

Revenue deficit = Revenue expenditure- Revenue receipts

This is a situation in which net amount received falls short of the projected net amount to be received. This occurs when the actual amount of revenue received and the actual amount of expenditures do not correspond with predicted revenue and expenditure figures. This is the opposite of a revenue surplus, which occurs when the actual amount exceeds the projected amount.

FISCAL DEFICIT-A fiscal deficit is the difference between the government’s total expenditure and its total receipts.

Gross Fiscal deficit = Total expenditure – Total receipts

Fiscal deficit is a measure of total borrowings required by the government. Greater fiscal deficit implies greater borrowings by the government. This creates a large burden of interest payments in the future that leads to increase in revenue expenditure, causing an increase in revenue deficit. Thus a vicious circle sets in

PRIMARY DFICIT-Primary deficit is the pure deficit which is derived after deducting the interest payments component from the total deficit of any budget.

Primary deficit = Fiscal deficit – interest payment

Primary deficit signifies borrowing requirements of the government. A low or zero primary deficit means that while government’s interest requirement on earlier loans have compelled the government to borrow but it is aware of the need to tighten its belt. 

DEFICIT FINANCING-

It is defined as Government funding of spending by borrowing. Planned expenditure by a government to put more money into the economy than it takes out by taxation, with the expectation that increased business activity will bring enough additional revenue to cover the shortfall. It is also called deficit spending.

The difference between revenue and expenditure is usually made up by borrowing or minting new funds. The influence of government deficits upon a national economy may be very great. Budget deficits may occur for numerous reasons; the term usually refers to a conscious attempt to stimulate the economy by lowering tax rates or increasing government expenditures. Deficit financing, may also result from government inefficiency, reflecting widespread tax evasion or wasteful spending rather than the operation of a planned countercyclical policy.

Where capital markets are undeveloped, deficit financing may place the government in debt to

foreign creditors. In addition, in many less-developed countries, budget surpluses may be

desirable in themselves as a way of encouraging private saving.

Deficit financing in India means the expenditure which in excess of current revenue and public borrowing. The government may cover the deficit in the following ways-

By running down its accumulated cash reserve from RBI. Issue of new currency by government itself. Borrowing from reserve bank of India and RBI gives the loans by printing more currency

notes.

The concept of deficit spending in economics is not limited to government use. Businesses of all sizes may choose to spend more money up front in hopes of generating funds to pay off the investment at a later date. Deficit financing is an approach to money management that involves spending more money than is collected during the same period.

One of the more common examples of government deficit financing has to do with stimulating the economy of a nation in order to bring an end to a period of recession. By establishing a specific plan of action that involves using borrowed resources to make purchases, the government can increase the demand for output from various sectors of the business community.

Household budgets also engage in this form of money management, although the role of deficit financing on an individual level takes a slightly different form than with businesses and governments.

The idea of deficit financing in economic development is not new. Economists from John Maynard Keynes up to the present day have recognized this strategy, its benefits, and its possible liabilities if not applied properly. While not automatically the best option to correct an

undesirable financial situation, its responsible use can ultimately improve the quality of life and the financial status of everyone concerned.

In India, deficit financing is used for raising resources for-

economic development redemption of public debt adjusting the balance of payments reducing the foreign debt

OBJECTIVES OF DEFICIT FINANCING-

1) To finance war- Deficit financing has generally being used as a method of financing war expenditure. During the war time through normal methods of raising resources. It becomes difficult to mobilize adequate resources. Therefore government has to adopt deficit financing.

2) Remedy for depression- In developed countries deficit financing is used as an instrument of economic policy for removing the conditions of depression. Prof. Keynes has also advocated for deficit financing as a remedy for depression and unemployment.

3) Economic development- The main objective of deficit financing in an under developed country like India is to promote economic development. The use of deficit financing in fact becomes essential for financing the development plan especially in underdeveloped countries.

4) Mobilization of Resources- deficit financing is also used for the mobilization of surplus, ideal and unutilized resources in the country.

5) For granting subsidies- In a country like India government grants subsidies to the producers to encourage them to produce a particular type of commodity, granting subsidies is a very costly affair which we cannot meet with the regular income this deficit financing becomes must for it.

6) Increase in aggregate demand- Deficit financing loads to increase in aggregate demand through increased public expenditure. This increase the income and purchasing power of the people as a consequence there is an increase availability of goods and services and the production and employment level also increase.

7) For payment of interest- Loan which are taken by the govt. are supposed to be repaid with their interest for that government needs money deficit financing is an important tool to get the income for the repayment of loan along with the interest.

8) To overcome low tax receipts.9) To overcome the losses of public sector enterprises. 10) To implement anti-poverty programs.

DEFICIT FINANCING SOURCES-

ADVERSE EFFECTS OF DEFICIT FINANCING   -

Deficit financing is not free from its defects. It has its adverse effect on economy. Important evil effects of deficit financing are given below-

1) Leads to inflation- Deficit financing may lead to inflation. Due to deficit financing, money supply increases & the purchasing power of the people also increase which increases the aggregate demand and the prices also increase.

2) Adverse effect on saving- Deficit financing leads to inflation and inflation affects the habit of voluntary saving adversely. Infect it is not possible for the people to maintain the previous rate of saving in the state of rising prices.

3) Adverse effect on Investment- deficit financing effects investment adversely when there is inflation in the economy trade unions make demand for higher wages for that they go for strikes and lock outs which decreases the efficiency of labour and creates uncertainty in the business which a decreases the level of investment of the country.

4) Inequality- in case of deficit financing income distribution becomes unequal. During deficit financing deflationary pressure can be seen on the economy which makes the rich richer and the poor, poorer. The fix wage earners are badly affected and their standard of living deteriorates thus the gap between rich & poor increases.

5) Problem of balance of payment- 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 import more commodities from abroad. This will create a deficit in balance of payment and the balance of payment will become unfavorable.

6) Increase in the cost of production- When deficit financing leads to the rise in the price level the cost of development projects also rises this means a larger dose of deficit financing is required on the port of government for completion of these projects.

7) Change in the pattern of investment- Deficit financing leads to inflation. During inflation prices rise and reach to a very high level in that case people instead of indulging into productive activities they start doing speculative activities.

GRAPHS –

IS DEFICIT FINANCING INFLATIONARY?

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. But if deficit financing is not kept within limits it may give rise to prices, distorted investment and unequal and unjust distribution of income. Therefore it is essential that deficit financing is kept within limits and its impact on prices and costs are softened through various controls.