What is Deficit Financing? What are the different types of deficit in the budget?

Deficit financing is the budgetary situation where expenditure is higher than the revenue. It is a practice adopted for financing the excess expenditure with outside resources. The expenditure revenue gap is financed by either printing of currency or through borrowing.

Nowadays most governments both in the developed and developing world are having deficit budgets and these deficits are often financed through borrowing. Hence the fiscal deficit is the ideal indicator of deficit financing.

In India, the size of fiscal deficit is the leading deficit indicator in the budget. It is estimated to be 3.9 % of the GDP (2015-16 budget estimates). Deficit financing is very useful in developing countries like India because of revenue scarcity and development expenditure needs.

Various indicators of deficit in the budget are:

  1. Budget deficit = total expenditure – total receipts
  2. Revenue deficit = revenue expenditure – revenue receipts
  3. Fiscal Deficit = total expenditure – total receipts except borrowings
  4. Primary Deficit = Fiscal deficit- interest payments
  5. Effective revenue Deficit-= Revenue Deficit – grants for the creation of capital assets
  6. Monetized Fiscal Deficit = that part of the fiscal deficit covered by borrowing from the RBI.

Simply budget deficit is printing money to finance a part of the budget. In India, there is no budget deficit at present. Hence one there is no budget deficit entry in Government’s budget. Another absent deficit identity is monetized fiscal deficit. This is borrowing by the government from RBI to finance the budget. Such a borrowing practice is not adopted in India from 1997 onwards. Hence the monetized fiscal deficit is also not there.

The leading deficit indicator and also the best one to measure the health of the budget in the Indian context is fiscal deficit. The fiscal deficit represents borrowing by the government. This borrowing is made by the government mostly from the domestic financial market by issuing bonds or treasury bills.

The root factor that cause deficit in the budget is the revenue deficit. Revenue deficit is the difference between revenue receipts and revenue expenditure in an accounting sense.

In recent years, government is following another deficit term called effective revenue deficit. Actually, revenue expenditure indicates expenditure to finance day to day functions of the government. They are not productive. But according to the government some revenue expenditure creates assets and hence is productive. This revenue expenditure which creates assets is deducted to get Effective Revenue Deficit.

The last type of deficit is Primary Deficit that shows the difference between fiscal deficit and interest payments.