DEFICIT FINANCING

DEFICIT FINANCING

Parveen Gulia

M. Tech Infrastructure Planning

 CONCEPT AND MEANING:-

Deficit financing refers to means of financing the deliberate excess of expenditure over income through printing of currency notes or through borrowings. The term is also generally used to refer to the financing of a planned deficit whether operated by a government in its domestic affairs or with reference to balance of payment deficit.

In the West, the phrase "Deficit financing" has been used to describe the financing of a deliberately created gap between public revenue and expenditure or a budgetary deficit. This gap is filled up by government borrowings which include all the sources of public borrowings viz., from people, commercial banks and the Central Bank. In t this manner idle savings in the country are made active. This increases employment and output. But according to Indian budgetary documents government resorting to borrowing from the public and the commercial banks does not come under deficit financing. These are included under the head of 'Market Borrowings' and government spending to the extent of its market borrowings does not result in or lead to deficit financing. In the Indian context, public expenditure, which is financed by borrowing from the public, commercial banks are excluded from deficit financing. While borrowing from the central bank of the country, withdrawal of accumulated cash balances and issue of new currency are included within its purview.

BUDGETARY DEFICIT:-

                           Budgetary deficit refers to the excess of total expenditure (both revenue and capital) over total receipts (both revenue and capital). In the words of the First Plan document, the term 'deficit financing' is used to denote the direct addition to gross national expenditure through budget deficits, whether the deficits are on revenue or on capital account. The essence of such a policy I lies, therefore, in government spending in excess of the revenue it receives in the shape of taxes, earnings of state enterprises, loans from the public, deposits and funds and other miscellaneous sources. The government may cover the deficit either by running down its accumulated balances or by borrowing from the banking system (mainly from the Central Bank of the country) and thus 'creating money'. Thus, the government tackles the deficit financing through approaching the Central Bank of the country i.e. Reserve Bank of India and commercial banks for credit and also by withdrawing its cash balances from the Central Bank.

The magnitude of actual budget deficit during the seventh plan had been of the order of Rs. 29,503 crore (at 1984-85 prices) which was more than double the estimate of Rs. 14,000 crore. The Budget for 1990-91 laid stress on limiting the size of the budget deficit through containment of expenditure growth and better tax compliance. The budget programmed a deficit of Rs. 1, 10,592 crore in 1989-90. The revised estimates for the year 1990-91 placed the budgetary deficit at Rs. 10,772 crore which is nearly 50% higher than the budget estimate. Proper financial management demands that the revenue receipts of the government, which are in the shape of taxes, loans from the public, earnings of the state enterprises etc., should not only meet the revenue expenditure but also leave a surplus for financing the plan. Contrary to this deficits on revenue account are growing year after year. For example the revised estimates place the deficit on revenue account during 1990-91 at Rs. 17,585 crore as against the budget deficit of Rs. 10,772 crore. A higher revenue deficit implies higher borrowed resources to cover the deficit leading to higher interest payments thus creating a sort of vicious circle.

ROLE OF DEFICIT FINANCING AS AN AD TO FINANCING ECONOMIC DEVELOPMENT:-

Deficit financing has been resorted to during three different situations in which objectives and impact of deficit financing are quite different. These three situations are war, depression and economic development.

DEFICIT FINANCING DURING WAR

Deficit financing has its historical origin in war finance. At the time of war, almost every government has to spend more than its revenue receipts from taxes and borrowings. Government has to create new money (printed notes or borrowing from the Central Bank) in order to meet the requirements of war finance. Deficit financing during war is always inflationary because monetary incomes and demand for consumption goods rise but usually there is shortage of supply of consumption goods.

DEFICIT FINANCING DURING DEPRESSION

The use of deficit financing during times of depression to boost the economy got impetus during the great depression of the thirties. It was Keynes who established a positive role for deficit financing in industrial economy during the period of, depression. It was advocated that during depression, government should resort to construction of public works wherein purchasing power would go into the hands of people and thereby demand would be stimulated. This will help in fuller utilisation of already existing but temporarily idle plants and machinery. Deficit spending by the government during depression helps to start the stagnant wheels of productive machinery and thus promotes prosperity.

DEFICIT FINANCING AND ECONOMIC DEVELOPMENT

Deficit financing for development, like depression deficit financing, provides stimulus to economic growth by financing investment, employment and output in the economy. On the other hand "development deficit financing7' resembles "war deficit * financing" in its effect on the economy. Both are inflationary though the reasons for price rise in both the cases are quite different. When government resorts to deficit financing for development, large sums are invested in basic heavy industries with long gestation periods and in economic and social overheads. This leads to immediate rise in monetary incomes while production of consumption goods cannot be increased immediately with the result that prices go up. It is also called the inflationary way of financing development. However, it helps rapid capital formation for economic development.

DEFICIT FINANCING AND INFLATION

Deficit financing in a developing country is inflationary while it is not so in an advanced country. In an advanced country the government resorts to deficit financing for boosting up the economy. There is alround unemployment of resources which can be employed by raising government investment through deficit financing. The result will be an increase in output, income and employment and there is no danger of inflation. The increase in money supply leading to demand brings about a corresponding increase in the supply of commodities and hence there is no increase ' in price level. But, when, in a developing economy, the government resorts to deficit financing for financing economic development the effects of this on the economy are quite different. Public outlays financed by newly-created money immediately create monetary incomes and, due to low standards of living and high marginal propensity to consume in general, the demand for consumption of goods and services increases. But if the public investment is on capital goods, then the increased demand for the consumer goods will not be satisfied and prices will rise. Even if the outlay is on the production of consumption goods the prices may rise because the monetary incomes will rise immediately while the production of consumer goods will take time and in the meanwhile prices will rise. Though investment is being continuously raised (through taxation, borrowing and external assistance), most of it goes to industries with long gestation period and for providing basic infrastructure. Though there is effective demand, resource5 lie under or unemployed. Lack of capital, technical skill, entrepreneurial skills etc. are responsible in many cases for unemployment or underemployment of resources in a developing economy. Under such conditions, when deficit financing is resorted to, it is sure to lead to inflationary conditions. Besides, in a developing economy, during the process of economic development, the velocity of circulation of money increases through the operation of the multiplier effect. This factor is also inflationary in character because, on balance, effective demand increases more than the initial increases in money supply. Deficit financing gives rise to credit creation by commercial banks because their liquidity is increased by the creation of new money. This shows that in a developing economy total money supply tends to increase much more than the amount of deficit financing, which also aggravates inflationary conditions. The use of deficit financing being expansionary becomes inflationary also on the basis of quantity theory of money.