Deficit Financing

Meaning :

Deficit financing is defined as financing the budgetary deficit through public loans and creation of new money. 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.

1. By running down its accumulated cash reserve from RBI.

2. Issue of new currency by government it self.

3. Borrowing from reserve bank of India and RBI gives the loans by printing more currency notes.

Objectives of deficit financing :

1. To finance war:- Deficit financing has generally being used as a method of financing war expenditure. During the war time through normal methods of raising resources. It becomes difficult to mobilize adequate resources. Therefore government has to adopt deficit financing.

2. Remedy for depression :- In developed countries deficit financing is used as on instrument of economic policy for removing the conditions of depression. Prof. Keynes has also advocated for deficit financing as a remedy for depression and unemployment.

3. Economic development:- The main objective of deficit financing in an under developed country like India is to promote economic development. The use of deficit financing in fact becomes essential for financing the development plan especially in underdeveloped countries.

4. Mobilization of Resources :- deficit financing is also used for the mobilization of surplus, ideal and unutilized resources in the country.

5. For granting subsidies :- In a country like India government grants subsidies to the producers to encourage them to produce a particular type of commodity, granting subsidies is a very costly affair which we cannot meet with the regular income this deficit financing becomes must for it.

6. Increase in aggregate demand :- Deficit financing loads to increase in aggregate demand through increased public expenditure. This increase the income and purchasing power of the people as a consequence there is an increase availability of goods and services and the production and employment level also increase.

7. For payment of interest:- Loan which are taken by the govt. are supposed to be repaid with their interest for that government needs money deficit financing is an important tool to get the income for the repayment of loan along with the interest.

8. To overcome low tax receipts.

9. To overcome the losses of public sector enterprises

10. For implementing anti poverty programme.


Deficit financing is not free from its diffects. It has its adverse effect on economy. Important evil effects of deficit financing are given below.

1. Leads to inflation :- Deficit financing may lead to inflation. due to deficit financing money supply increases & the purchasing power of the people also increase which increases the aggregate demand and the prices also increase.

2. Adverse effect on saving:- Deficit financing leads to inflation and inflation affects the habit of voluntary saving adversely. Infect it is not possible for the people to maintain the previous rate of saving in the state of rising prices.

3. Adverse effect on Investment ;- deficit financing effects investment adversely when there is inflation in the economy trade unions make demand for higher wages for that they go for strikes and lock outs which decreases the efficiency of Labour and creates uncertainty in the business which a decreases the level of investment of the country.

4. Inequality :- in case of deficit financing income distribution becomes unequal. During deficit financing deflationary pressure can be seen on the economy which make the rich richer and the poor, poorer. The fix wage earners are badly effected and their standard of living detoriates thus no gap b/w rich & poor increases.

5. Problem of balance of payment :- Deficit financing leads to inflation. A high price level as compared to other countries will make the exports more expensive and thus they start declining. On the other hand rise in domestic income and price may encourage people to import more commodities from abroad. This will create a deficit in balance of payment and the balance of payment will become unfavorable.

6. Increase in the cost of production :- When deficit financing leads to the rise in the price level the cost of development projects also rises this means a larger dose of deficit financing is required on the port of government for completion of these projects.

7. Change in the pattern of investment:- Deficit financing leads to inflation. During inflation prices rise and reach to a very high level in that case people instead of indulging into productive activities they start doing speculative activities.

Is Deficit Financing Inflationary?

Deficit financing may not necessarily be inflationary there are certain conditions under which deficit financing may not lead to inflation. With increase in money supply due to deficit financing prices do rise but rise in price will only be temporary for about a period. As flow of goods and services increase prices will began to fall. deficit financing is an important device for financing development plans for underdeveloped countries and accelerate their rate of economic development. But If deficit financing is not kept with in limits It may give rise to prices, distorted investment and unequal and unjust distribution of income. therefore it is essential that deficit financing is kept within limits and its impact on prices and costs are softened through various controls.


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  2. I've a doubt in deficit financing. Why does RBI print new currency when it grants loan to the government?


    1. this is because the load amount is huge and this cannot be collected solely by borrowings from public. so they have to print more money.

  3. tanks for this great help me a lot....

  4. plssss send me urgently...The role of deficit financing in budget @

  5. how deficit financing increase the domestic cost of production?

  6. how deficit financing increase the domestic cost of production?

  7. Deficit financing gives rise to inflation where consumers purchasing power increases due to which even raw material dealers and other variable factor increases price of therir goods or sevice as demand inreases (law of demand). As, a result cost of inputs increases causing increase in cost of domestic cost of production...
    I hope this ans. was helpful to u..