Deficit Financing and It’s Impact on Economic Development

Deficit financing is today a major instrument in the hands of governments, both in developed and under-developed countries to finance a warrior to carry, out a programme of economic development.

In the advanced private enterprise countries, deficit financing is resorted to ensure continued high levels of economic activity and to offset the occasional tendencies to a decline in private spending, especially private domestic investment.


Lately, the under-developed countries have increasingly realised its potentialities for adding Jo the resources available for development. Thus, deficit financing is becoming, indeed, an important lever for ensuring continued high level of activity in the advanced countries and for accelerating economic development in the less developed countries.

What is Deficit Financing?

According to/the Indian Planning Commission, deficit financing is equal to the net increase in the purchasing power of the economy arising out of the budgetary operations of the government. Deficit financing is said to have been practiced whenever government expenditure exceeds the receipts from the public, i.e., from taxes, fees and public borrowings.

Such an excess of government expenditure can be financed either by drawing down the cash balances of the government (held in the Reserve Bank of India or in the State treasuries) or by borrowing from the Reserve Bank of India. Both these methods of financing the deficit would have the effect of expanding money supply held by the public.


Thus, according to the definition of deficit financing, it is that part of government expenditure which is met either by drawing down the cash balances of the government or by resorting to borrowing from the Reserve Bank of India. This definition of deficit financing, therefore, identifies it with that part of government expenditure the finance of which leads to a net increase in money supply with the public.

Deficit Financing and Economic Development:

What scope is there for deficit financing to be used as an instrument of economic development in the under-developed countries like India? We know that the basic problem confronting these countries is that of a population growing much faster than the rate of capital formation. If these countries are to provide full employment to their labour force, they need huge amounts of capital. Unlike the advanced economies, the problem facing under-developed countries is not one of deficiency of effective demand, but the lack of sufficient capital.

In advanced capitalist countries, the task of capital formation is in the hands of private entrepreneurs, but in poor countries there is a dearth of people willing and able to undertake entrepreneurial functions. Hence, if these countries are to develop rapidly, the responsibility must rest with the govern­ment.

The basic problem mentioned above (i.e., population growth exceeding capital formation) can be solved only by increasing the rate of investment. This requires additional resources and, in the absence of sufficient foreign aid, they can come out only through increased domestic savings and their being channelised along productive lines. One way of increasing domestic savings is through additional voluntary efforts on the part of the public.

These savings are then utilised through the national small saving schemes to add to the resources available to the government.But in a country, where a majority of people are living at the subsistence level, the margin between income and consumption is very low so that voluntary savings, howsoever welcome, cannot by themselves provide sufficient resources for development. The government may also attempt to increase the volume of resources by additional taxes.

During the last few years, taxes have been increased in our country to find resources for economic development. Yet because of the extreme poverty of the great mass of the people, additional taxation beyond a point raises difficult problems, both economic and political Hence, in their anxiety to implement development schemes, the governments are compelled to resort to deficit financing.

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