Budget Deficit and Deficit Financing:
Deficit financing is referred to the excess of expenditure incurred by the Government over the receipts they get by way of taxes, fees, loans from domestic savings, and miscellaneous other items, including foreign grants and loans.
Thus the term deficit financing is used to denote the direct addition to gross national expenditure through budget deficit. The deficit may be covered by the Government by running down its accumulated cash balances or by borrowing from the banking system (mainly from the Reserve Bank of India) and thus creating fresh money. Hence, deficit financing in India has been defined by the Planning Commission as “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 capital accounts.” It implies that the expenditure of the Government over and above the aggregate receipts of the revenue account and capital account is treated as a budget deficit of the government.
The borrowing from the general public and Commercial Bank and income from State enterprises etc. cannot be used to cover the budget deficits in India as in advanced countries since they are treated as the receipts of the capital account. The Government may cover its deficit either by running down its accumulated balance or by borrowing from the banking system mainly from the Central Bank of the country and thus creating fresh money. Thus, loans taken from the Central Bank and creating fresh currency or running down its accumulated balances are called the methods of financing the budget deficit in India.
Deficit financing thus refers to the ways in which the budgetary gap is financed. The government resorts to this method of financing when it is unable to cover its total expenditure from normal sources of revenue, such as taxation, fees, income from government properties and undertakings, proceeds of loans, small savings, and other capital receipts and funds at its disposal. Deficit financing, in that case, can be undertaken by the government by drawing upon its accumulated cash balance or borrowing from the Central Bank of the country or by both.
This definition of budget deficit as used in India links up budget deficits with the effect on liquid assets held by the public. The effects of deficit financing are measured by the increase in the volume of money. Thus, deficit financing also includes the effects of fiscal operations on the volume of money.
Deficit financing is, therefore, a wider concept than budgetary deficit, since it also includes the effects of deficit financing. To assess the impact of the Government’s fiscal operations or deficit financing, the concept of Net Reserve Bank Credit to the Government is used.
A point that needs to be emphasized in this context is that there is a qualitative difference between the Reserve Bank Credit to the Government and Commercial Bank Credit to the government. Extension of credit by the Reserve Bank leads to the generation of “high powered money” which constitutes the base of multiple creations of credit by Commerical Banks. Extension of credit by Commerical Banks represents a transfer of savings from the household sector to the government sector through the intermediation of Commerical Banks. Therefore, while credits by the commercial Bnaks as well as by the Reserve Bank are expansionary, the credit given by the Reserve Bank has greater inflationary potential than the credit given by the commercial banks because of the multiplier effect of the Reserve Bank Credit. Since the budgetary deficits of the Government of India are generally financed by running down its accumulated balances or by borrowing mainly from the Reserve Bank of India, (which means expansion of currency), therefore, deficit financing in India may be said to be more expansionary in its effects than otherwise, it could have been.
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