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    What is deficit financing?

    Synopsis

    For developing countries like India, higher economic growth is a priority. A higher economic growth requires finances. With the private sector being shy of making huge expenditure, the responsibility of drawing financial resources rests on the government.

    Agencies
    Deficit financing effects investment adversely. When there is inflation in the economy employees demand higher wages to survive. If their demands are accepted it increases the cost of production which de-motivates the investors.
    Deficit financing means generating funds to finance the deficit which results from excess of expenditure over revenue. The gap being covered by borrowing from the public by the sale of bonds or by printing new money.

    Why we need deficit financing
    For developing countries like India, higher economic growth is a priority. A higher economic growth requires finances. With the private sector being shy of making huge expenditure, the responsibility of drawing financial resources rests on the government.

    Often both the tax and non-tax revenues fail to mobilize enough resources just through taxes. The deficit is often funded through borrowings or printing new currency notes.

    What are the pitfalls of deficit financing
    Printing new currency notes increases the flow of money in the economy. This leads to increase in inflationary pressures which leads to rise of prices of goods and services in the country. Deficit financing is inherently inflationary. Since deficit financing raises aggregate expenditure and, hence, increases aggregate demand, the danger of inflation looms large.

    Retail inflation in India already shot up to a five-and-a-half-year high of 7.35% in December, breaching the central bank’s tolerance limit of 6% and confirming fears raised by some economists that India is entering a phase of slow growth and rising prices.

    What are the effects on investment?
    Deficit financing effects investment adversely. When there is inflation in the economy employees demand higher wages to survive. If their demands are accepted it increases the cost of production which de-motivates the investors.

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