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Deficit Financing is Bad Economics But Good Politics

Col Dinesh Kumar (11214) &Lt. Col I.K. Lal (11219)

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• Deficit financing is resorted to during three different situations :-

• During War

• During Depression

• During Economic Development

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Deficit Financing

• Deficit financing occurs when there are budgetary deficits.

• Budgetary Deficit is excess of total expenditure both revenue and capital over total receipts.

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• Besides taxation, the government’s other major revenue source is borrowing.

• Deficit Financing refers to financing the difference of expenditure over revenue through borrowings.

• Higher deficit implies higher borrowings and thus higher interest payments.

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• Deficits have generally been the rule (although there was a surplus from 1999 to 2000).

• Deficit (as fraction of GDP) was highest in mid-1980s.

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Deficit Financing And Inflation

• Deficit financing creates monetary incomes and demand for goods and services increases.

• Though there is increased demand, availability of consumer goods takes time & prices rise.

• Also increase in money supply lead to credit creation which aggravates inflationary conditions.

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Price Rise

• There is a close relationship between rate of increase in prices & growth in money supply.

• Prices have tendency to rise at every successive increase in money supply.

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Limitation of Deficit Financing

• Deficit financing is inevitable under planned economic development to activate unutilized resources or step up tempo of economic process.

• It is necessary to the extent it can promote capital formation and economic development.

PATTERN OF DEFICIT FINANCING• Gross Fiscal Deficit comprises of revenue & capital

deficit.

• Revenue deficit has shown continuous increasing trend.

• Almost 60% of deficit is due to non plan expenditure.

(i) Interest payment

(ii) Defence

(iii)Subsidies & inefficient PSUs

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HEAVY INTREST BURDEN

• Continuous increase in revenue deficit depicts continuous deterioration in the fiscal situation.

• Considerable part of net borrowings is utilized simply for payment of interest.

• Public borrowings not being used for productive investment but only for consumption expenditure.

• It further widens the gap between net revenue & net expenditure.

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WAY OUT OF FINANCIAL CRISIS

• Prudent fiscal management is need of the hour.

• Reduce growth of revenue expenditure by cutting down subsidies, introducing agriculture income tax, etc.

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GOOD POLITICS MEANS BAD ECONOMICS

Hence, we have

• Fiscal profligacy in place of prudence.

• Policy paralyses

• Food security act instead of subsidies

• Concern of political India – maintain fuel subsidy, announce populist schemes

• Concern of productive India – steep decline of rupee, fiscal deficit BoP crunch, retrospective tax, steady decline in GDP growth.

Thank you