What is deficit financing?

An excess of estimated expenditure over the estimated revenue over a specific period of time is known as fiscal deficit. The term deficit financing is generally referred to as a technique used by a government to manage the ‘Fiscal Deficit’ in budgetary situations. Governments across the world normally resort to cover the deficit (the gap between excess of expenditure over revenue) by borrowing from the public through the sale of bonds, disinvestment of Government’s stake in public sector enterprises, by printing new money,  etc.

The purposes of Deficit Financing:

There are some situations when deficit financing becomes absolutely essential like;

• To meet the financial requirement of the government during emergencies like war.
• To mobilize adequate resources for financing economic developments.
• To control the economic fluctuations and to raise the level of the employment and output
• To meet the expenditure on poverty alleviation programs of the Government.

Problems of deficit financing:

Most of the developing countries being poor, these countries fail to mobilize large resources through taxes. Therefore, taxation has narrow coverage due to mass poverty. A Government relies on the profits of public sector enterprises. However, in a country like India, these enterprises yield almost a negative profit.  Another source is public borrowing by the sale of bonds, but there is a limit to public borrowing. The disinvestment of government stake in public sector enterprises creates privatization of certain state entities that may make the monopoly of private parties over specific services. These private organizations may eventually seek to increase prices of the services at the detriment of the consumer with no controls. Further, the government loses dividends after privatization as seen with most successful companies that are developed through privatization. These dividends are instead channeled to wealthy individuals. Printing new currency notes increases the flow of money in the economy. This leads to an increase in inflationary pressures which lead to the rise in prices of goods and services in the country.

Deficit financing can be used for developmental purposes as well as for covering war-cost. The deficit financing used for developmental purposes is fixed primarily with reference to what is considered as the desirable rate of growth for the economy. The levels of outlay laid down are of an order which cannot be met only by taxation and borrowing from the public. Thus the deficit financing helps the government to achieve its target much earlier than it can be achieved in the normal course.  However, deficit financing undertaken by a government for covering war-cost is construed as an unproductive expenditure.

Deficit financing is inherently inflationary, more so when deficit financing is made for the persecution of war.  However, a mild dose of inflation is necessary for economic development. Therefore, if the government is able to keep the inflation in the country within a reasonable level, deficit financing will promote economic development —thereby neutralizing the disadvantages of price rise. But, when inflation goes too far, deficit financing becomes self-defeating.