Previous Year Question

When total Government expenditure exceeds its available non-debt receipts, the gap has to be financed through borrowing or other financial means. This is broadly associated with Deficit Financing.

Fiscal Deficit is expressed as:

Fiscal Deficit=Total Expenditure-Revenue Receipts-Non-debt Capital Receipts

It indicates the Government’s total borrowing requirement.

Option (a) is correct

A developing economy such as India requires substantial investment in:

• Roads, railways, ports and energy

• Irrigation and agricultural infrastructure

• Education and healthcare

• Industrialisation

• Employment generation

• Social and economic infrastructure

When Tax and Non-tax Revenue are insufficient to meet these developmental requirements, the Government mobilises additional resources through borrowing or deficit financing.

If the borrowed funds are used for productive Capital Expenditure, they may:

• Increase the economy’s productive capacity.

• Crowd in Private Investment.

• Generate employment and income.

• Expand the future Tax Base.

Thus, the principal purpose of Deficit Financing in India has been to mobilise resources for Economic Development.

Option (b) is incorrect

Public Debt Redemption means repaying the principal amount of an existing Government debt. Deficit Financing normally creates fresh borrowing or liabilities.

If the Government borrows afresh merely to repay maturing debt, it amounts to debt rollover or refinancing. It does not necessarily create additional developmental resources or eliminate the underlying debt burden.

Therefore, redemption of public debt is not the primary objective.

Option (c) is incorrect

The Balance of Payments records economic transactions between a country’s residents and the rest of the world. Measures for correcting an external imbalance may include:

• Increasing exports

• Moderating imports

• Attracting capital inflows

• Exchange-rate adjustment

• Using Forex Reserves

Financing the domestic Budget Deficit does not automatically correct the Balance of Payments. If deficit-induced demand increases imports, it may instead intensify external-sector pressures.

Option (d) is incorrect

Deficit Financing is not intended specifically to reduce foreign debt. The Government may finance its deficit from domestic as well as external sources. It may therefore increase total public liabilities in certain circumstances.

Important fact about monetised deficit

When a deficit is financed directly through the Central Bank and the creation of new reserve money, it is called Monetisation of Deficit.

If money supply rises considerably faster than output, it can generate inflationary pressure. Therefore, the following remain important:

• Using borrowing for productive Capital Expenditure;

• Maintaining debt sustainability; and

• Containing the Fiscal Deficit within prudent limits.

India discontinued the system of automatic monetisation through ad hoc Treasury Bills in 1997 and introduced the Ways and Means Advances—WMA system.