Day 12 – Q 1.What is deficit financing? What are the different types of deficits? Examine their implications and significance.

1. What is deficit financing? What are the different types of deficits? Examine their implications and significance. 

घाटा वित्तपोषण क्या है? विभिन्न प्रकार के घाटे क्या हैं? उनके निहितार्थ और महत्व की जांच करें।

Introduction:

Deficit refers to the excess of total expenditure over receipts (excluding borrowings) during the particular year. It is a budgetary situation where expenditure is higher than the revenue. The expenditure revenue gap is financed by either printing of currency or through borrowings.

Body

Purpose of “deficit financing”

• To enable government to obtain necessary resources for the plans.
• The levels of outlay laid down cannot be met by taxation and borrowing from public.

Different types of deficits:

Primary deficit= fiscal deficit- Interest payments

Primary deficit is defined as fiscal deficit of current year minus interest payments on previous borrowings. Fiscal deficit indicates borrowing requirement inclusive of interest payment, primary deficit indicates borrowing requirement exclusive of interest payments. 

Implications:

• If a primary deficit of a country is shrinking it means fiscal health of economy is improving,
• A zero primary deficit means that government has to resort to borrowing just to make payment interest.
• If primary deficit is equal to fiscal deficit, then there is no interest payments
• Any government that doesn’t borrow to consume is considered to be prudent in fiscal management.

Significance:

• It is a narrower concept, because it includes interest payments.
• It is basic measure of fiscal responsibility.

Fiscal deficit= total expenditure- total receipts except borrowings

Fiscal deficit is defined as excess of total budget expenditure over total budget receipts except borrowings during fiscal year. It is a measure how much government needs to borrow from market to meet its expenditure when its resources are inadequate.

Implications:

• A larger fiscal deficit implies large amount of borrowing.
• Unnecessary expenditure: high fiscal deficit leads high expenditure which in turn leads to inflation.
• Pressure of inflation: deficit financing may lead to printing of currencies which have effect of inflation.
• Debt traps: fiscal deficit is financed by borrowing. It has an effect of repayment of loans and payment of interest can increase.

Significance:

• Fiscal deficit shows the borrowing requirements of government during the budget year.
• Global investors are much interested because high fiscal deficit may push the out of market due to high inflation and interest rate regime can impact profitability.

Revenue deficit= total revenue expenditure- total revenue receipts

Revenue deficit is excess of total revenue expenditure of government over its total revenue receipts.

Implications:

• Government spends more than what it collects.
• It leads to reduction of assets that is either borrowing or selling its existing assets.
• With more and more borrowings it leads to larger revenue deficit.

Significance:

• It impacts credit rating of government because consistent running a deficit implies that government is unable to meets its current and future recurring obligations.
• Increase in revenue deficit is places many government expenditure in jeopardy.

Effective revenue deficit= revenue deficit- grants for the creation of capital assets

It is the difference between revenue deficits and grants for the creation of capital assets. This excludes those revenue expenditures which are done in form of grants for creation of capital assets.

Implication:

• Help in reducing the consumptive component of revenue deficit.
• It creates space for increased capital spending.

Significance:

• It was introduced to ascertain actual deficit in revenue account after adjusting for expenditure of capital nature.
• It intended to cure the distortions caused by large scale transfers to other entities for the creation of capital assets.

• Monetized fiscal deficit= borrowing from RBI

 It is that part of deficit financing which is supported by the RBI. This includes two things: 1) Borrowings from the RBI. 2) Decrease of government’s balance in RBI (for the sake of simplicity just know that government maintains some balance with RBI).

Conclusion

Deficit financing can be achieved through borrowings from market, borrowing from RBI or drawing from government. The government should ensure that resources mobilized through deficit financing are channelized for capital formation and economic development.