The phrase ‘ Deficit financing’ is used to mean any public expenditure that is in excess of current public revenues . In advanced countries deficit financing is used to describe the financing of deliberately created gap between public revenue and public expenditure or a budgeting deficit . Thus Govt. expenditure financed by borrowing from the public is included in deficit financing . Another method usually followed is deficit financing by ‘ created money’. Deficit financing in context of an LDC’s[ Less developed countries] has a different connotation. It includes expenditure financed by borrowing from the public . According to the Indian Planning Commission , ” 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 lies in the Govt. 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 Govt. may cover the deficit either by running downs its accumulated balances or by borrowing from the banking system[ mainly from central bank of the country and thus ‘created money ‘]. Thus deficit financing includes:[a] withdrawal of past accumulated cash balances by the Govt., [b] borrowing from the central bank and [c] issuing of new currency by the govt. In India these methods are in use.
Role of Deficit financing :-
Deficit financing is the most useful method of promoting economic development in less developed countries . Generally less developed countries suffer from lack of sufficient financial resources to support required investment to promote economic development. So on account of the lack of sufficient resources to finance public investment, govt. have to resort to the method of deficit financing.
Deficit financing may be used for the development of economic and social overheads such as construction of roads , railways , power projects , schools, hospitals etc . By providing socially useful capital , deficit financing is able to break bottlenecks and structural rigidity and thereby increases productivity.
Further , deficit financing by increasing money incomes augments community savings . It is an effective instrument of forced savings . When the Govt. resorts to deficit financing, it takes away real resources from the people. Moreover deficit spending by the state on development projects leads to increased employment , output and income . The increased incomes tends to raise the demand for consumer goods which leads to the rise n prices due to deficit supplies . This process leads to inflation. In such a situation , a part of the increased incomes can be taken away through taxation by the Govt. It is another way of forced savings which can be utilized for capital formation.
The rationale of deficit is that it tends to raise the income of the enterpreneurial class which has a high propensity to save . During inflationary periods , wages and other fixed costs do not rise to the same extent as the rise in prices . This tends to raise profits which are used for higher investment and capital formation . At the same time inflation tends to reduce the real income of the fixed income group and thereby their propensity to save . But the loss in the propensity to save of the fixed income earners is compensated more than proportionately by the rise in the propensity to save of the variable income earners . Deficit financing thus combines in itself both the fiscal and monetary polices . It acts as a fiscal measure which inflation operates as an engine of forced saving through taxation . It is a monetary measure when it creates new money through a deficit budget.
Deficit financing is always expansionary in its effects, as development gains momentum the rate of investment in the economy is accelerated which requires a additional does of the quantity of money at every stage – [a] With a continuous increase in investment the total physical product is likely to be higher than before thereby necessitating a corresponding increase in supply of money for transaction purposes.[b] As the economy develops the non- monetized sector is gradually transformed into the monetized sector leading to an increase in the demand for money. [c] A process of continuous economic development leads to rise in incomes thus increasing the demand for cash balances on the part of the people. [d] In the event of an import surplus due to increasing foreign aid , the demand for money is likely to be still greater . It is through deficit financing that the Govt. can meet the increasing demand for money in all these cases . Thus a policy of deficit financing is an important and fruitful instrument for capital formation in underdeveloped countries.———————————————————————————————————————————————————————————————————————————————-The End.—————————————————————————-