Many of us think that why their income is always less than their expenses. Actually, this is applicable not only to people but to billion dollar economies as well. That is the reason that government of almost every country in the world rely on the deficit financing system.
Meaning of Deficit Financing
Former Planning Commission of India has defined deficit financing as;
"The direct addition to gross national expenditure through budget deficits, whether the deficits are on capital or on revenue account.”
So whenever the expenditure of the government exceeds its revenue then government envisage the process of deficit financing. So the temporary arrangement of the funds through various methods is known as deficit financing.
Sources of Deficit Financing
The deficit financing is done in three ways;
1. Printing new currency notes
2. Borrowing from internal sources (RBI, General Public, Ad-hoc Treasury Bills & government bonds etc.)
3. Borrowing from External Sources (like borrowing from developed countries and International institutions like World Bank, IMF, etc.)
Deficit Financing in India
In India, when the total income of the government (revenue account + capital account) falls below its total expenditure, then;
1. Government withdraws money from its cash deposited in the Reserve Bank or
2. Borrows loan from the central bank and commercial banks and even state governments through Ad-hoc Treasury Bills.
3. Borrows from the general public in the form of Bonds and other securities or
4. Orders the RBI to print new currency notes
Keep in mind that the above 4 measures increase the supply of money in the market which leads to increase the rate of inflation in the country. That is the reason that deficit financing is known as “Idea of Money Supply. also”
It is worth to mention that deficit financing is equal to fiscal deficit of the country.
Purposes of Deficit Financing;
1. To overcome the problem of lack of funds for speeding up the country's development.
2. Promote additional investment in the country to side away the adverse impacts of depression period of the country.
3. To arrange fund for ensuring the holistic development of the country.
4. To arrange fund for the unforeseen events and arrange resources for wartime expenditure.
5. To upgrade the infrastructure of the country so that the taxpayers of the country are convinced that the tax paid by them is spent on the right things.
Impacts of the Deficit Financing on the country
1. Increase in inflation due to the increase in the supply of money in the economy.
2. Decrease in average consumption level due to higher inflation.
3. Increase in income disparities, because rich get more opportunities due to higher supply of money in the economy.
4. Adverse Impact on Saving:- Deficit financing leads to inflation and inflation affects the habit of voluntary saving adversely.
In fact it is not possible for the people to maintain the previous rate of saving due to rising prices.
5. Adverse Impact on Investment: - Deficit financing effects investment adversely. When there is inflation in the economy trade unions/employees demand higher wages to survive.
If their demands are accepted it increases the cost of production which de-motivates the investors.
Famous economist Keynes was the strong supporter of the deficit financing in the developing countries so that these countries can be pulled out from the vicious circle of poverty, unemployment and under production.
In essence it can be said that the deficit in the country is not as bad as it looks like. Perhaps this is the reason that the deficit finance system is used in every rich country of the world.