What is deficit financing ? Explain its implications for the indian economy?
Answers
Deficit financing is a method of meeting government deficits through creation of alternative ways for instance printing of more new money. This deficit may arise when the government spends more than it receives.
In India, it led to rise in inflation where the prices of goods and services increased. on the other hand it can as well benefit the country by ensuring that resources are used at the right time and this in turn leads to increased development in the country.
Deficit financing in advanced countries means an excess of expenditure over revenue—the deficit being covered by borrowing from the public by the sale of bonds and by creating new money. In India, and other developing countries, the term deficit financing is explained in a restricted sense.
The National Planning Commission of India has defined deficit financing as the direct addition to gross national expenditure through budget deficits, whether the deficits are on revenue or on capital account.The essence of such policy lies in government spending in excess of the revenue it receives. The government may cover this deficit either by running down its accumulated balances or by borrowing from the banking system (mainly from the central bank of the country).
Implications of Fiscal Deficit:
1. Debt Trap:
Fiscal deficit indicates the total borrowing requirements of the government. Borrowings not only involve repayment of principal amount, but also require payment of interest.
Interest payments increase the revenue expenditure, which leads to revenue deficit. It creates a vicious circle of fiscal deficit and revenue deficit, wherein government takes more loans to repay the earlier loans. As a result, country is caught in a debt trap.
2. Inflation:
Government mainly borrows from Reserve Bank of India (RBI) to meet its fiscal deficit. RBI prints new currency to meet the deficit requirements. It increases the money supply in the economy and creates inflationary pressure.
3. Foreign Dependence:
Government also borrows from rest of the world, which raises its dependence on other countries.
4. Hampers the future growth:
Borrowings increase the financial burden for future generations. It adversely affects the future growth and development prospects of the country