CONTENTS-

SR. NO

TOPIC

PAGE NO.

INTRODUCTION

DEFICIT

DEFICIT FINANCING

DEFICIT FINANCING AS AN AID

11

DEFICIT FINANCING AND INFLATION

12

DEFICIT FINANCING AND PRICE BEHAVIOUR

13

ADVANTAGES OF DEFICIT FINANCING

15

LIMITATIONS OF DEFICIT FINANCING

17

MEASURES TO CONTROL DEFICIT FINANCING

19

10

CONCLUSION

21

11

BIBLIOGRAPHY

22

INTRODUCTION1

The use of deficit financing to maintain total spending or effective demand was an important
discovery of the economic depression of 1930. Today it is a major instrument in the bands
of government to ensure high levels of economic activity. The definition of deficit financing is
likely to vary with the purpose for which such a definition is needed. Deficit financing is an
approach to money management that involves spending more money than is collected during the
same period.
Sometimes referred to as a budget deficit, this strategy is employed by corporations and small
businesses, governments at just about every level, and even household budgets. When used
properly, deficit financing helps to launch a chain of events that ultimately enhances the financial
condition rather than simply creating debt that may or may not be repaid.
One of the more common examples of government deficit financing has to do with stimulating
the economy of a nation in order to bring an end to a period of recession. By establishing a
specific plan of action that involves using borrowed resources to make purchases, the
government can increase the demand for output from various sectors of the business community.
This in turn motivates businesses to hire additional employees, reversing the usual trend
of higher unemployment that takes place during a recession. At the same time, the renewed vigor
in the marketplace helps to restore consumer confidence, making it more likely for consumers
to buy more goods and services.
When monitored closely, a carefully crafted deficit financing initiative will restore a measure of
stability to the national economy over a period of months or years. The concept of deficit
spending in economics is not limited to government use. Businesses of all sizes may choose to
spend more money up front in hopes of generating funds to pay off the investment at a later date.
For example, a manufacturer may choose to purchase new machinery for a factory, with the
understanding that the newer equipment will allow the business to produce more units of goods
in less time, and possibly at a lower unit cost. Over time, the benefits derived from this strategy
pay off the accumulated debt and allow the business owners to enjoy a budget surplus rather than
a budget deficit.
Household budgets also engage in this form of money management, although the role of deficit
financing on an individual
level takes a slightly different form than with businesses and
governments.

DEFICIT2

A deficit is the amount by which a sum falls short of some reference amount.
A situation in which outflow of money exceeds inflow. That is, a deficit occurs when agovernme
nt, company, or individual spends more than he/she/it receives in a given period of time, usually
a year. One's deficit adds to one's debt, and, therefore, many analysts believe that deficits are
unsustainable over the long-term.
Sources of financing economic development are broadly divided into domestic and foreign
sources. Domestic sources of finance at the disposal of the government consist of taxation,
public borrowing and government savings which include surpluses of public enterprises and
deficit financing.
The foreign finances consist of loans, grants and private investments. All these
sources
of
finance have their social costs and benefits on the basis of which an upper limit can be
determined forthe useof any one method of financing development. Since the financialrequireme
nts of development are enormous and all various sources have their own limitations,
it becomes almost essential to make use of all the sources as far as possible. The choice is not bet
ween which one is to be used but between the various combinations of using all of them.
Thus both the domestic and foreign sources of finance have their own place and importance in ad
eveloping country. It is essential to formulate appropriate policies for different sources of finance
and successful implementation of these policies is required for achieving the desired objectives
of rapid economic development.
Domestic sources of financing economic development are sure to fall short of the huge financial
requirements for rapid economic development in developing economies. So, external sources
of finance have become almost essential for the developing economy. In spite of the necessity
of foreign assistance, it remains only a subordinate source of financing development in a
developing economy.
In the early stages of development a substantial foreign assistance may be needed but gradually
foreign assistance as a percentage of development expenditure goes on diminishing as the
developing nations must learn gradually to become self-reliant. Hence various conventional
sources of finance, such as taxation, public borrowing, having been found to be inadequate,
deficit financing has been resorted to for meeting the resource gap.
The idea of resorting to deficit financing for economic development, which is of relatively recent
origin, has remained very controversial. But there are no two opinions regarding the evil
consequences of deficit financing, when adopted carelessly for capital formation and economic
development.

In economics, a deficit is an excess of expenditures over revenue in a given time period. When a
government spends more than it collects by way of revenue, it incurs a budget deficit. There are
various measures that capture government deficit and they have their own implications for the
economy.

REVENUE DEFICITRevenue deficit refers to the excess of governments revenue expenditure over revenue
receipts.
Revenue deficit = Revenue expenditure- Revenue receipts
This is a situation in which net amount received falls short of the projected net amount to
be received. This occurs when the actual amount of revenue received and the actual
amount of expenditures do not correspond with predicted revenue and expenditure
figures. This is the opposite of a revenue surplus, which occurs when the actual amount
exceeds the projected amount.

FISCAL DEFICITA fiscal deficit is the difference between the governments total expenditure and its total
receipts.
Gross Fiscal deficit = Total expenditure Total receipts
Fiscal deficit is a measure of total borrowings required by the government. Greater fiscal
deficit implies greater borrowings by the government. This creates a large burden of
interest payments in the future that leads to increase in revenue expenditure, causing an
increase in revenue deficit. Thus a vicious circle sets in

PRIMARY DFICITPrimary deficit is the pure deficit which is derived after deducting the interest payments
component from the total deficit of any budget.
Primary deficit = Fiscal deficit interest payment
Primary deficit signifies borrowing requirements of the government. A low or zero
primary deficit means that while governments interest requirement on earlier loans have
compelled the government to borrow but it is aware of the need to tighten its belt.

DEFICIT FINANCING4

Deficit financing refers to means of financing the deliberate excess of expenditure over income
through printing of currency notes or through borrowings. The term is also generally used to
refer to the financing of a planned deficit whether operated by a government in its domestic
affairs or with reference to balance of payment deficit.
In the West, the phrase "Deficit financing" has been used to describe the financing of a
deliberately created gap between public revenue and expenditure or a budgetary deficit. This gap
is filled up by government borrowings which include all the sources of public borrowings viz.,
from people, commercial banks and the Central Bank. In this manner idle savings in the country
are made active. This increases employment and output.
But according to Indian budgetary documents government resorting to borrowing from the
public and the commercial banks does not come under deficit financing. These are included
under the head of 'Market Borrowings' and government spending to the extent of its market
borrowings does not result in or lead to deficit financing.
In the Indian context, public expenditure, which is financed by borrowing from the public,
commercial banks are excluded from deficit financing. While borrowing from the central bank of
the country, withdrawal of accumulated cash balances and issue of new currency are included
within its purview.
Deficit financing in Indian context occurs when there are budgetary deficits. Let us now discuss
the meaning of budgetary deficit. Budgetary deficit refers to the excess of total expenditure (both
revenue and capital) over total receipts (both revenue and capital).
In the words of the First Plan document, 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 on capital account.
The essence of such a policy lies, therefore, in government spending in excess of the revenue it
receives in the shape of taxes, earnings of state enterprises, loans from the public, deposits and
funds and other miscellaneous sources.
The government may cover the deficit either by running down its accumulated balances or by
borrowing from the banking system (mainly from the Central Bank of the country) and thus
'creating money'.
Thus, the government tackles the deficit financing through approaching the Central Bank of the
country i.e. Reserve Bank of India and commercial banks for credit and also by withdrawing its
cash balances from the Central Bank

Where capital markets are undeveloped, deficit financing may place the government in debt to
foreign creditors. In addition, in many less-developed countries, budget surpluses may be
desirable in themselves as a way of encouraging private saving.
So, deficit financing in India means the expenditure which in excess of current revenue and
public borrowing. The government may cover the deficit in the following ways

By running down its accumulated cash reserve from RBI.

The concept of deficit spending in economics is not limited to government use. Businesses of all
sizes may choose to spend more money up front in hopes of generating funds to pay off the
investment at a later date. Deficit financing is an approach to money management that involves
spending more money than is collected during the same period.
One of the more common examples of government deficit financing has to do with stimulating
the economy of a nation in order to bring an end to a period of recession. By establishing a
specific plan of action that involves using borrowed resources to make purchases, the
government can increase the demand for output from various sectors of the business community.
Household budgets also engage in this form of money management, although the role of deficit
financing on an individual level takes a slightly different form than with businesses and
governments.
The idea of deficit financing in economic development is not new. Economists from John
Maynard Keynes up to the present day have recognized this strategy, its benefits, and its possible
liabilities if not applied properly. While not automatically the best option to correct an
undesirable financial situation, its responsible use can ultimately improve the quality of life and
the financial status of everyone concerned.
In India, deficit financing is used for raising resources for

economic development
redemption of public debt
adjusting the balance of payments
reducing the foreign debt

Deficit financing, may also result from government inefficiency, reflecting widespread tax
evasion or wasteful spending rather than the operation of a planned countercyclical policy.

DEFICIT FINANCING AS AN AID

deficit financing during war

A) DEFICIT FINANCING DURING WARDeficit financing has its historical origin in war finance. At the time of war, almost every
government has to spend more than its revenue receipts from taxes and borrowings.
Government has to create new money (printed notes or borrowing from the Central Bank)
in order to meet the requirements of war finance.
Deficit financing during war is always inflationary becausemonetary
incomes
and
demand for consumption goods rise but usually there is shortage of supply of
consumption goods.
B) DEFICIT FINANCING DURING DEPRESSIONThe use of deficit financing during times of depression to boost the economy got impetus
during the great depression of the thirties. It was Keynes who established a Expositive
role for deficit financing in industrial economy during the period of, depression.
It was advocated that during depression, government should resort to construction of
public works wherein purchasing power would go into the hands of people and thereby
demand would be stimulated. This will help in fuller utilization of already existing but
temporarily idle plants and machinery.
Deficit spending by the government during depression helps to start the stagnant wheels
of productive machinery and thus promotes prosperity.
C) DEFICIT FINANCING AND ECONOMIC DEVELOPMENTDeficit financing for development, like depression deficit financing, provides stimulus to
economic growth by financing investment, employment and output in the economy.
On the other hand "development deficit financing' resembles "war deficit financing" in its
effect on the economy. Both are inflationary though the reasons for price rise in both the
cases are quite different.

When government resorts to deficit financing for development, large sums are invested in
basic heavy industries with long gestation periods and in economic and social overheads.
This leads to immediate rise in monetary incomes while production of consumption
goods cannot be increased immediately with the result that prices go up. It is also called
the inflationary way of financing development. However, it helps rapid capital formation
for economic development.

DEFICIT FINANCING AND INFLATIONDeficit financing in a developing country is inflationary while it is not so in an advanced country.
In an advanced country the government resorts to deficit financing for boosting up the economy.
There is all round unemployment of resources which can be employed by raising government
investment through deficit financing. The result will be an increase in output, income and
employment and there is no danger of inflation.
The increase in money supply leading to demand brings about a corresponding increase in the
supply of commodities and hence there is no increase in price level. But, when, in a developing
economy, the government resorts to deficit financing for financing economic development the
effects of this on the economy are quite different.
Public
outlays
financed by newly
created money immediately create monetary incomes and, due to lowstandards of living and high
marginal propensity to consume in general, the demand for consumption of goods and services
increases.
But if the public investment is on capital goods, then the increased demand for the consumer
goods will not be satisfied and prices will rise. Even if the outlay is on the production of
consumption goods the prices may rise because the monetary incomes will rise immediately
while the production of consumer goods will take time and in the meanwhile prices will rise.
Though
investment
is
being
continuously
raised
(through
taxation, borrowing and external assistance),
most
of it goes to industries
with long gestation period and for providing basic infrastructure. Though there is effective
demand, resources lie under or unemployed. Lack of capital, technical skill, entrepreneurial skills
etc. are responsible in many cases for unemployment or underemployment of resources in a
developing economy. Under such conditions, when deficit financing is resort to, it is sure to
lead to inflationary conditions. Besides, in a developing economy, during the process of
economic development, the velocity of circulation of money increases through the operation of
the multiplier effect. This factor is also inflationary in character because, on balance, effective
demand increases more than the initial increases in money supply.
8

Deficit
financing
gives
rise
to
credit
creation
by commercialbanks because their liquidity is increased by the creation of new money. This sho
ws that in adeveloping economy total money supply tends to increase much more than the
amount of deficit financing, which also aggravates inflationary conditions. The use of deficit
financing being expansionary becomes inflationary also on the basis of quantity theory of money.

DEFICIT FINANCING AND PRICE BEHAVIOUR IN INDIAPrice stability is an essential condition for stability in economic life as well as economic growth.
On the contrary, fluctuations in prices create an atmosphere of uncertainty which is not
conducive to development activity.
When we examine the price movements during the planning period in India, there are three clear
trends. First during the first plan period (i.e. 1951 to 1956) the general price level had fallen from
1955-56 to 1965-66. The prices rose steadily at an annual rate of 6%. Finally, from 196667onwards (except 1975-76 and 1977-78) prices rose at the rate of about 0% per annum and now
it is in the double digit range.
Deficit financing as a tool for covering the financial gap in India was introduced at the time
of formulation of first five year plan. During the first plan deficit financing was of the order of
Rs.333 crore and the money supply with the public increased by about 22 per cent. Since this
expansion in the supply of money fell short of the increase in output, the general price level came
down by about 18 per cent.
During second plan, actual deficit financing was less than the targeted amount, The third plan
was very abnormal (adverse weather conditions, 1962 Chinese aggression, 1965 Pakistan war).
Deficit financing during the third plan amounted to Rs. 1333crore - more than double the target.
Money supply with the public increased more rapidly.
In the fourth plan (1969-71), the amount of deficit financing stood at Rs. 2060 crore-about twoand-a-half times the target. Money supply increased from 6387 crore to Rs. 11,172 crore at the
end of 1973-74. Prices increased by 47% approximately.
No doubt there were certain factors beyond the control of the government such as war
with Pakistan in 1971, substantial expenditure on account of Bangladesh refugees, oil price hike
etc. Besides, the reluctance on the part of the states to mobilize adequate resources, their general
financial indiscipline and overdrafts from the Reserve Bank also compelled the government to
take resort to deficit financing.

In view of severe inflationary pressures in the economy since 1972-73, the draft fifth plan 197479 laid utmost stress on non-inflationary methods of financing. But, as against the target of
Rs.1354 crore for the fifth five year plan, the actual amount of deficit financing was much more.
During this period, although the money supply increased by about 50 per cent, the overall
increase in wholesale prices was 33% because of the imposition of emergency in 1975 resulting
in comfortable position in regard to the availability of sever: commodities through the effective
management of supplies.
During the sixth plan (1980-8.5) deficit financing was of the order of Rs. 15.681 crore as against
the estimated target of Rs. 5000 crore. During this period money supply increased from Rs.
23,117 crore-in 1980-81 to Rs. 39,380 crore in 1984-85.
Seventhplan paper indicated a cautious approach towards deficit financing and stated that "The
require resources have to be mobilized in a manner which minimize dependence on external
sources or on deficit financing which has a high inflationary potential. Still the target for deficit
financing was placed at Rs, l1,000 crore and according to the latest estimates the actual deficit
financing has been of the order of Rs. 34,182 crore i.e. more than 2.4 times the target.
Money supply with the public has increased from Rs. 43.599 crore in 1985-86 to Rs. 76.259
crore in 1988-89 and index of wholesale prices has gone up from 357.8 to 435.8 during the same
period.
Thereweremany other factors like mismanagement of the war economy. Excessive dependence
on monsoon, power shortage, labour strikes, increase in the rates of commodity taxation, rise in
wage rates, black money, rise in the international price of petroleum products which have been
responsible for price rise in India.
However, experience shows that the increase in money supply has led to a rise in prices. There
has been a close relationship between the rate of increase in prices and the rate of growth in
money
supply
and prices have a tendency to rise to new heights at every successive increase in money supply
resulting from deficit financing.
When deficit financing is inflationary, it will go against the very purpose for which it is
used because it will simply lead to continuous inflation and no development.
Inflation creates uncertainty, labour unrest, work stoppages and decline in production because of
the demand for higher wages and salaries to compensate for higher cost of living. Inflation
reduces the real income and the real consumption of all classes of people in the society except
the rich.
This is objectionable on grounds of economic efficiency, labour productivity and social justice.
Moreover, there is no certainty that higher levels of income accruing to profit earners will be
10

invested in one productive enterprises, for the rich may waste windfall gains in conspicuous
consumption or indulge in speculative activities.
Besides, inflation is a sort of invisible tax on all incomes and cash balances. Their value is
automatically reduced with every rise in prices. Inflation leads to balance of payments
difficulties because due to rising prices the country loses export market and people prefer
imported goods which appear cheaper as compared to domestic goods.
Inflation is charged with distorting the pattern of investment and production in the economy.
Inflation is beset with the danger of channelizing economic resources into less urgent and
speculative fields where the scope for profits to private enterprises is more and such fields
are generally of little importance to the nation.
Inflationary deficit financing increases the administrative expenditure of the government because
whenever government resorts to large doses of deficit financing, it has to neutralize its effects by
sanctioning new dearness allowances, revision of controlled prices, distribution of essentials
through fair price shops, compulsory requisition of foodstuffs etc.
All these measures lead to an increase in the administrative burden of the government in order
to ward off inflation caused by the use of deficit financing.

ADVANTAGES OF DEFICIT FINANCINGUp till now, we have seen that deficit financing is inflationary and it destroys its own purpose
of aiding economic development. But it is not always so. Secondly, inflation is not always
harmful for economic development.
On the contrary, to a certain extent inflation is conducive to economic development and hence
deficit financing is beneficial. During the process of development, increase in national
production is bound to give rise to the demand for increased money supply for transactions. This
can be met by injecting new money in the economy through deficit financing.
If deficit financing is resorted to for productive purposes especially for the production of
consumer goods and that too for quick results then deficit financing is not that inflationary.
For example, if any land reclamation activity is to beundertaken which would lead to agricultura
l production, resort to deficit financing for thisactivity will not be inflationary. Even if there is a
moderate price increase of 4 to 5% per annum, its impact on the economy will not be too severe.
Besides, deficit financing will not be inflationary if it is matched by a balance of payment deficit.
To the extent to which past savings of foreign balances can be used to pay for such imports, it
would be deflationary.
11

But much reliance cannot be put on balance of payments deficit because balance of payments
deficit depends on our foreign exchange reserves and our credit worthiness in the world market.
Moreover, a developing country aims at reducing this deficit by increasing exports and reducing
imports. Deficit financing will be non-inflationary if the government is able to mop up the
additional money incomes, created by deficit financing, through taxation and saving schemes.
Properly controlled and efficiently managed programme of deficit financing may help the
process of economic development. In fact a certain measure of deficit financing is inevitable
under planned economic development to activate unutilized or dormant resources especially
when one of the objectives of planning is to step up the inflationary impact of deficit financing
is helpful for economic development to a certain extent and under certain circumstances like :
a) Under developed countries, with their low incomes, low or negative savings, inadequate
investment and traditional resistance to change and modernisation, will remain stagnant or
develop at an intolerably slow pace unless they are restructured and activated. This can be done
with the stimulus of inflation.
b) Inflation stimulates economic activities and rising prices induce more 'investments. In adevelo
ping economy the major goal is rapid economic development through speedy capital formation.
The additional income that is earned through inflation can be ploughed back and if the same
process is repeated there is every possibility of a rapid rate of capital formation in the country.
For this, inflation may be tolerated to a certain extent.
c) Inflation is said to be a useful method of increasing saving in a forced way. There will be
redistribution within the private sector of the economy, from the personal sector to corporate
sector. Inflation reduces real consumption and provides resources for investment purposes. Thus,
deficit financing is a necessary and positive instrument to accelerate the rate of economic
growthin countries suffering from acute shortage of capital. But any deficit financing has to be
undertaken in the context of an efficient and well executed plan for economic development.

LIMITATIONS OF DEFICIT FINANCINGDeficit financing (as we have examined up till now) can be regarded as a necessary evil which
has to be tolerated, at least in the developing economies, only to the extent it can promote capital
formation and economic development.

12

This extent of tolerance is called the safe limit of deficit financing. This safe limit shows the
amount of deficit financing that the economy can absorb and beyond which inflationary
forces may be set in motion.
Though it is not possible to quantify it, yet it is desirable to identify the factors that affect it.
Factors that affect deficit financing, can be put under two categories:
(a) Factors related to demand for money and
(b) Factors related to supply of money. If the demand for money is low in the economy, the safe
limit of deficit financing will be low. Then creation of new money or deficit financing must be
kept at a low level otherwise evil consequences will follow. Reverse will be the case when
demand for money is high.
On the supply side of money, if due to some factors the supply of money or purchasing power
with the public increases, other things being equal, it will have an inflationary tendency and the
safe limit of deficit financing will be low. However, safe limit will be high in the opposite
situation. The concept of safe limit of deficit financing can be reduced to the age old theory of
demand and supply.
The point at which demand for and supply of money are equal is the point of safe limit of, deficit
financing. Unfortunately conditions in a developing country are not so simple.
Various factors simultaneously exert contradictory effects on each side.

Factors Affecting Safe Limiti)

The safe limit of deficit financing depends on the supply elasticity of consumption
goods in the country. Usually, the supply of consumption goods, especially food
grains, cannot be increased to any extent for a long time due to many constraints in a
developing economy. Under such circumstances even a little deficit financing would
be inflationary and the safe limit of deficit financing will be very low.

ii)

Safe limit of deficit financing also depends on the nature of government expenditure
for which new money is created, i.e., the purpose of deficit financing. If the newly
created money is used for unproductive purposes, the use of deficit financing will be
inflationary and the safe limit of deficit financing will be lower than if the newly
created money is to be used for industrial development or for intensive farming.

iii)

If the foreign exchange reserves are increasing the scope of using deficit financing
will increase because that way the country will be able to import more goods which
will have deflationary effect.
13

iv)

Time lag between the initial investment and the flow of final products also determines
the safe limit of deficit financing. If this time lag is long, then inflation will set in
from the very initial stage of investment and it will not be possible to control the
rapidly rising prices.

v)

Low safe limit of deficit financing is required if the economy consists of large
speculative business community.

vi)

If government is not in position to implement successfully its economic policies

vii)

If a country is already passing through inflationary phase, low deficit financing is

viii)

If the rate of growth of population is high then low deficit financing is good and vice
versa.

ix)

Safe limit deficit financing also depends on a country's tax structure and the
borrowing schemes through which the government can take away at least a portion of
additional incomes thereby reducing the purchasing power with the public. But all
this is not easy in a developing economy where there are rigidities in the tax system.
There is large scale tax evasion so that government is not able to take away any
substantial part of additional incomes.
The country is, therefore, more prone to inflation and the safe limit of deficit
financing is low in a developing economy, all the aforesaid factors exert their
influence simultaneously. The effect of each factor may be favorable or unfavorable
for the use of deficit financing and sometimes the effects of some factors may counter
affect each other and, thus, be cancelled out.
This safe limit of deficit financing will be different for different countries because
conditions vary from country to country. The safe limit of deficit financing also
depends on the measure of popular cooperation which the government gets and the
willingness of the people to submit to austerity. Even if this limit is calculated, it will
go on changing with every change in the economic conditions of the country.
With efforts in the right direction this limit can be shifted upwards so that a larger
amount of deficit financing\ can be resorted to by a government which is conducive to
economic development and not inflation.

14

MEASURES TO CONTROL DEFICIT FINANCINGBesides open deficit financing undertaken by the government, there is concealed deficit
financing in developing economies. In all government departments, in a developing country most
of the expenditure is incurred recklessly in the last few weeks of the financial year so that the
amount sanctioned may not lapse.
This reckless expenditure is largely a waste and is not accompanied by expected results. This
expenditure is fairly large every year. It is not productive and it leads to price rise and operates in
the economy in a manner similar to deficit financing. Most of the havoc created in the economy
is actually created by this concealed deficit financing.
If, by efficient and honest administration, this vast wasteful expenditure can be avoided, the
officially acknowledged deficit financing will not be so inflationary. Anti-social acts such as
evasion of taxes, black marketing, cash transactions to supplement recorded cheque transactions,
under invoicing and over invoicing of export and imports, and a variety of such forms of
corruption on the part of the private parties lead to large volume of 'unaccounted money'.
This money is to be spent recklessly and it leads to inflationary rise in prices. Government must
try to remove reckless expenditure in public and private sectors caused by 'concealed deficit
financing' and 'unrecorded gains' instead of stopping the use of deficit financing which is likely
to be spent productively and therefore help in the economic development of the country.
In order to minimize the inflationary effects of deficit financing during the process of Resource
Mobilization development the government will have to keep a vigilant and constant watch on
changing economic situations, study the repercussions of measures adopted in several spheres
and, above all, take effective action on following lines :
a) Government should try to drain off
a larger proportion of funds resulting from deficit
financing through saving campaign and higher taxation.
b) The policy of deficit financing should be adopted as a last resort, after exhausting all other
possible sources of development finance.
c) Investment should be channeled into those areas where capital output ratio is low so that
returns are quick and price rise is not provoked.
d) Along with deficit financing, government should adopt policies of physical controls like price
control and rationing etc.
e) Import policy should allow import of necessary capital equipment for economic development
and consumer goods required by the masses alone. Import of luxury and semi-luxury goods
should be discouraged.

15

f) Deficit financing and credit creation policies should be integrated in such a way that neither
of the two sectors (public or private) is handicapped due to shortage of financial resources and, at
the same time, inflation is also kept in check in the economy.
Above all these policies, what is more required is that the government should try to seek
full public cooperation and people should have full faith in the policies of the government so that
government
policies
can
be
successfully
implemented.
Deficit financing or no deficit financing, the process of economic development itself is
inflationary.
Whenever new investment is financed by taxation or borrowing, the result is an increase
in monetary incomes, increase in demand for consumption goods, and price rise. With this
background the important question, in a developing country, is not whether deficit financing
should be resorted to or not for economic development, but, rather, how far inflation can
be pushed without upsetting the productive process.
Thus deficit financing is a necessary and positive instrument to accelerate the rate of economic g
rowth in countries suffering from acute shortage of the capital, though it is necessary to
emphasize here that it must be undertaken with an efficient and well executed plan for economic
development.

CONCLUSIONDeficit financing as a method of resource mobilization has assumed an important place in public
finance in recent times. It refers to the means of financing the deliberate excess of expenditure
over income through printing of currency notes or through borrowing.
In this unit, we have discussed the meaning of deficit financing, its role as an aid to financing
economic development in various situations. Deficit financing in a developing country becomes

16

inflationary and it has varied effects on economic development which have been highlighted in
the unit.
We have also examined the impact of deficit financing on price behavior in India during the plan
period.
It shows that, apart from other factors, there has been a close relationship between rate of
growth of money supply resulting from deficit financing and rate of increase in prices.
But to a certain reasonable extent, deficit financing has proved to be conducive to economic
development, especially in countries with acute shortage of capital.
The advantages of deficit financing in this context have been dealt with in the unit. As we have
discussed in the unit deficit financing in developing economies can be regarded as a necessary
evil which can be tolerated only to the extent it promotes capital formation and economic
development.
This extent of tolerance is known as safe limit of deficit financing. To minimize the inflationary
effects of deficit financing during the process of development, certain measures have to be taken
like proper channelizing of investment in areas with low capital output ratio, adoption of policies
of physical control likerationing, import of only necessary capital equipment etc.
In economies with low capital formation, deficit financing becomes a necessary and positive
instrument if used with efficient and well executed plan of economic development.

BIBLIOGRAPHY

http://www.britannica.com
http://www.gktoday.in
http://www.businessdictionary.com
http://www.yourarticlelibrary.com
http://articles.economictimes.indiatimes.com
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 http://www.na-businesspress.com
http://ezinearticles.com
http://www.thefreedictionary.com

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