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Articles From General Knowledge Today: Deficit Financing
Articles From General Knowledge Today: Deficit Financing
Articles From General Knowledge Today: Deficit Financing
Deficit Financing
2012- 11- 24 12:11:12 GKToday
Def icit ref ers t o t he dif f erence bet ween expendit ure and receipt s. In public
f inance, it means t he government is spending more t han what it is earning.
Government expendit ure and revenue can be split int o capit al and revenue.
Capit al expendit ure generally includes t hose expenses which result in creat ion
of asset s. Revenue expendit ure is primarily t hat which does not result in asset
creat ion —f or example int erest payment s, salaries, subsidies, et c. Similarly,
on t he receipt s side, what ever t he government receives as t axes is revenue
receipt . Receipt s not of a recurring nat ure are generally capit al receipt s.
T hese include domest ic and ext ernal borrowings, proceeds of disinvest ment ,
recovery of loans given by t he Union government , et c.
T he basic int ent ion behind def icit f inancing is t o provide t he necessary
impet us t o economic growt h by art if icial means. However, def icit f inancing
helps t o a cert ain ext ent only and beyond t hat it may cause havoc. Here are
some of t he problems of def icit f inancing.
1. Leads to inf lation :- Def icit f inancing may lead t o inf lat ion. Due t o def icit
f inancing money supply increases & t he purchasing power of t he people also
increase which increases t he aggregat e demand and t he prices also
increases.
2. Adverse ef f ect on saving:- Def icit f inancing leads t o inf lat ion and inf lat ion
af f ect s t he habit of volunt ary saving adversely. Inf ect it is not possible f or t he
people t o maint ain t he previous rat e of saving in t he st at e of rising prices.
4. Inequality :- in case of def icit f inancing income dist ribut ion becomes
unequal. During def icit f inancing def lat ionary pressure can be seen on t he
economy which make t he rich richer and t he poor, poorer. T he f ix wage
earners are badly ef f ect ed and t heir st andard of living det eriorat es t hus no
gap b/w rich & poor increases.
5. Problem of balance of payment :- Def icit f inancing leads t o inf lat ion. A
high price level as compared t o ot her count ries will make t he export s more
expensive and t hus t hey st art declining. On t he ot her hand rise in domest ic
income and price may encourage people t o import more commodit ies f rom
abroad. T his will creat e a def icit in balance of payment and t he balance of
payment will become unf avourable.
7. Change in the pattern of investment:- Def icit f inancing leads t o inf lat ion.
During inf lat ion prices rise and reach t o a very high level in t hat case people
inst ead of indulging int o product ive act ivit ies t hey st art doing speculat ive
act ivit ies.
India resort ed t o def icit f inancing, t hen largely f inanced t hrough Reserve
Bank's books eit her by print ing more money or use of it s f oreign exchange
reserves, right f rom t he early years of planned economic development .
However, our planners did not f act or in t he impact of def icit f inancing on
inf lat ion. But wit h large f oreign exchange reserves, t hey were conf ident of t he
government 's abilit y t o manage t he supply-side of t he economy.
For much of t he 1950s, t he Bank was part of t his consensus. Alt hough t he
impact of def icit f inancing on prices had aroused concern already in 1951-52 ,
price st abilit y did not ret urn as a major cause of worry at t he Bank unt il t he
mid-50 s. Besides, t he Bank recognised t he need f or any plan t o go beyond
what available resources dict at ed, even if some part of t he addit ional
invest ment had t o be f inanced t hrough addit ions t o money supply.
Def icit f inancing is neither good nor bad. it depends upon t he circumst ances in
which it is resort ed t o and t he economic policy which is f ollowed t o neut ralize
it s adverse consequences. A cert ain measure of def icit f inancing is inevit able
in India under t he planned economic development as one of t he object ives of
t he planning is t o st ep up t he t empo of t he economic progress beyond what it
would have been in absence of planning. As f ar as def icit f inancing does not
lead t o inf lat ion , t here is no object ion t o it s use. However , unf ort unat ely,
ext ent t o which India has been pract icing def icit f inancing has gone way
beyond what could possibly have been cont emplat ed by Lord Keynes.