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Public Debt and Deficit Financing

26-NOV-2015 14:34

    Public debt records the summation of all government borrowings less repayments that are denominated in a country's home currency. Public debt should not be confused with external debt, which reflects the foreign currency liabilities of both the private and public sector and must be financed out of foreign exchange earnings. Public debt in Indian reference is considered as the borrowings of the central and state governments.

    India's external debt stock stood at US$ 475.8 billion at end-March 2015 as against US$ 446.3 billion at end-March 2014. Notwithstanding the increasing external debt stock during 2014-15, crucial debt indicators such as external debt-GDP ratio and debt service ratio remained in the comfort zone. External debt of the country continues to be dominated by the long term borrowings. Government arranges money from deficit financing (borrowing from general public, printing new currency and borrowing from external sources) if its expenditure exceeds revenue.

    A. Internal Liabilities

    Information on internal liabilities divided into four parts: (1) Internal debt, (2) Small savings, Deposits and Provident Funds, (3) Other Accounts, and (4) Reserve Funds and Deposits.

    1. Internal Debt. Are market loans, treasury bills, and securities issued to international financial institutions?

    Market Loans. These have a maturity of 12 months or more at the time of issue and is generally interest bearing. The government issues such loans almost every year. These loans are raised in the open market by sale of securities or otherwise. In addition to market loans, the government has also issued bonds from time to time like gold bonds.

    Treasury Bills. Treasury bills have been a major source of short-term funds for the government to bridge the gap between revenue and expenditure. They have a maturity of 91 or 182 or 364 days and are issued every Friday. Treasury bills are issued to the Reserve Bank of India, State governments, commercial banks and other parties.

    Securities Issued to International Financial Institutions. The Government of India contributes towards the capital of international financial institutions such as International Monetary Fund, International Bank for Reconstruction and Development, and International Development Association. These contributions are by the way of non-negotiable, non-interest bearing securities and the Government of India is liable to pay the amount at the call of these institutions.

    2. Small Savings, Deposits and Provident Funds: Small savings have consistently increased in volume over the years due to the rising money incomes in the economy and also due to the various innovative schemes introduced by the government. Some of these schemes involved attractive tax concessions (like 6- Year National Savings Certificates, VI, VII and VIII issues) and people were thus lured into channeling substantial amounts of money through these schemes. As far as provident funds are concerned, they are divided into two categories: (i) State Provident Fund and (ii) Public Provident Fund.

    3. Other Accounts: These include mainly Postal Insurance and Life Annuity Fund, Hindu Family Annuity Fund, Borrowing against Compulsory Deposits and Income Tax Annuity Deposits, and Special Deposits of Non- Government Provident Fund.

    4. Reserve Funds and Deposits: Reserve Funds and Deposits are divided into two categories: (i) interest bearing and (ii) non-interest bearing. They include Depreciation and Reserve Funds of Rail ways and Department of Posts and Department of Telecommunications, deposits of Local Funds, departmental and judicial deposits, civil deposits etc.

    B. External Liabilities

    Under-developed countries need foreign aid in the early stages of economic development to sustain a high level of investment, purchase capital equipment and machinery from abroad and to cover the balance of payments gap. The Government of India has raised foreign loans from a number of countries like USA, UK, France, former USSR, Germany etc. and international financial institutions like IMF, IBRD, IDA etc. As a result, external liabilities of the Central government have increased considerably from Rs. 11,298 crore as at end-March 1981 to Rs. 31,525 crore as at end-March 1991 and further to Rs. 1,56,347 crore as at end-March 2011. Currently India’s Government debt to GDP is 66% as on Dec. 2014.

    Meaning: Deficit Financing

    Dr. V.K.R.V. Rao defines deficit financing as “the financing of a deliberately created gap between public revenue and public expenditure or a budgetary deficit, the method of financing resorted to being borrowing or a type those results in a net addition to national outlay or aggregate expenditure.” Deficit financing implies creation of additional money supply. Methods to cover the deficit financing are:

    • By running down Government’s accumulated cash reserve from RBI.

    • Sale of government securities to the institutions/general public/ corporate houses

    • Borrowing from Reserve Bank of India and RBI gives the loans by printing more currency notes.

    Objectives of Deficit Financing:

    To Bear War expenditure:- Deficit financing, generally being used as a method of financing   big expenditure plans. It becomes difficult to arrange adequate resources. Therefore government has to adopt deficit financing.

    Diagnosis of Depression: - In developed countries/developing countries deficit financing is used as instrument of economic policy for removing the conditions of depression, because these countries suffer from lack of demand in the markets. Prof. Keynes has also suggested deficit financing as a remedy for depression and unemployment.

    Promotion of Economic development:- The main objective of deficit financing in an under developed country/ developing country like India is to promote economic development. Deficit financing additional money in the hands of the government to promote development works.

    Resources Mobilization: - deficit financing eases the movement of resources from one place to other, which created demand in the economy.

    To Grant Subsidies :- In a country like India government grants subsidies to the producers(farmers, entrepreneurs etc.) 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.

    Increase in Aggregate Demand: Deficit financing leads to increase in aggregate demand through increased public expenditure. This increases the income and purchasing power of the people and increases the availability of goods and services followed by the production and employment level.

    Negative Effects of Deficit Financing

    Deficit financing is not free from its defects. It also has some negative impacts on economy. Important evil effects of deficit financing are given below.

    Inducement to Inflation: - Deficit financing may lead to inflation because deficit financing increases money supply & the purchasing power of the people which leads to increase in the price of the commodities.

    Adverse Impact 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.

    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 and de-motivates investors.

    DISCLAIMER: JPL and its affiliates shall have no liability for any views, thoughts and comments expressed on this article.

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