UNIT V

BUDGET
Syllabus
i. Budget – Meaning and Components
ii. Balanced Vs Unbalanced Budget
iii. Types of Deficit – Revenue, Fiscal, Primary and budgetary deficit
iv. Deficit Financing

BUDGET: MEANING AND COMPONENTS

“A government budget is an annual financial statement showing item
wise estimates of expected revenue and anticipated expenditure during a
fiscal year.”
Government has several policies to implement in the overall task of
performing its functions to meet the objectives of social & economic
growth. For implementing these policies, it has to spend huge amount of
funds on defence, administration, and development, welfare projects &
various other relief operations. It is therefore necessary to find out all
possible sources of getting funds so that sufficient revenue can be
generated to meet the mounting expenditure.
A budget is a financial statement prepared prior to a defined period of
time, of the policy to be pursued during that period for the purpose of
attaining a given objective. Planning process of assessing revenue &
expenditure is termed as Budget.
The term budget is derived from the French word "Bougette" which
means a "leather bag" or a "wallet". It is a statement of the financial plan
of the government. It shows the income & expenditure of the
government during a financial year, which runs generally from 1stApril
to 31st March.
Budget is most important information document of the
government. Every citizen of a nation from the common man to the
politician is eager to know about the budget as they would like to get an
idea of the:
1. Financial performance of the government over the past one year.
2. To know about the financial programmes & policies of the
government for the next one year.
3. To know how their standard of living will be affected by the
financial policies of the government in the next one year.
According to Taylor, "Budget is a financial plan of government for a
definite period".
According to Rene Storm, "A budget is a document containing a
preliminary approved plan of public revenues and expenditure".
Main elements of the budget are:
(i) It is a statement of estimates of government receipts and expenditure.
(ii) Budget estimates pertain to a fixed period, generally a year.
(iii) Expenditure and sources of finance are planned in accordance with
the objectives of the government.
(Iv) It requires to be approved (passed) by Parliament or Assembly or
some other authority before its implementation.

Objectives of a Government budget

Some of the important objectives of government budget are as follows:
1. Allocation of Resources 2. Reducing inequalities in income and
wealth 3. Economic Stability 4. Management of Public Enterprises 5.
Economic Growth and 6. Reducing regional disparities.
Government prepares the budget for fulfilling certain objectives. These
objectives are the direct outcome of government’s economic, social and
political policies.
The various objectives of government budget are:
1. Allocation of Resources:
Through the budgetary policy, Government aims to allocate resources in
accordance with the economic (profit maximization) and social (public
welfare) priorities of the country. Government can influence allocation
of resources through:
(i) Taxes or subsidies:
To encourage investment, government can give tax concession,
subsidies etc. to the producers. For example, Government discourages
the production of harmful consumption goods (like liquor, cigarettes
etc.) through heavy taxes and encourages the use of ‘Khaki products’ by
providing subsidies.
(ii) Directly producing goods and services:
If private sector does not take interest, government can directly
undertake the production.
2. Reducing inequalities in income and wealth:
Economic inequality is an inherent part of every economic system.
Government aims to reduce such inequalities of income and wealth,
through its budgetary policy. Government aims to influence distribution
of income by imposing taxes on the rich and spending more on the
welfare of the poor. It will reduce income of the rich and raise standard
of living of the poor, thus reducing inequalities in the distribution of
income.
3. Economic Stability:
Government budget is used to prevent business fluctuations of inflation
or deflation to achieve the objective of economic stability. The
government aims to control the different phases of business fluctuations
through its budgetary policy. Policies of surplus budget during inflation
and deficit budget during deflation helps to maintain stability of prices in
the economy.
4. Management of Public Enterprises:
There are large numbers of public sector industries (especially natural
monopolies), which are established and managed for social welfare of
the public. Budget is prepared with the objective of making various
provisions for managing such enterprises and providing those financial
help.
5. Economic Growth:
The growth rate of a country depends on rate of saving and investment.
For this purpose, budgetary policy aims to mobilize sufficient resources
for investment. Therefore, the government makes various provisions in
the budget to raise overall rate of savings and investments in the
economy.
6. Reducing regional disparities:
The government budget aims to reduce regional disparities through its
taxation and expenditure policy for encouraging setting up of production
units in economically backward regions.

Impact of a budget:
A budget impacts the society at three levels, (i) It promotes aggregate
fiscal discipline through controlled expenditure, given the quantum of
revenues, (ii) Resources of the country are allocated on the basis of
social priorities, (iii) It contains effective and efficient programmes for
delivery of goods and services to achieve its targets and goals.

Components of Government Budget

The main components or parts of government budget are explained
below.

1. Revenue Budget
This financial statement includes the revenue receipts of the government
i.e. revenue collected by way of taxes & other receipts. It also contains
the items of expenditure met from such revenue.
(a) Revenue Receipts
These are the incomes which are received by the government from all
sources in its ordinary course of governance. These receipts do not
create a liability or lead to a reduction in assets.
Revenue receipts are further classified as tax revenue and non-tax
revenue.
i. Tax Revenue:-
Tax revenue consists of the income received from different taxes and
other duties levied by the government. It is a major source of public
revenue. Every citizen, by law is bound to pay them and non-payment is
punishable.
Taxes are of two types, viz., Direct Taxes and Indirect Taxes.
Direct taxes are those taxes which have to be paid by the person on
whom they are levied. Its burden cannot be shifted to someone else. E.g.
Income tax, property tax, corporation tax, estate duty, etc. are direct
taxes.
Indirect taxes are those taxes which are levied on commodities and
services and affect the income of a person through their consumption
expenditure. Here the burden can be shifted to some other person. E.g.
Custom duties, sales tax, services tax, excise duties, etc. are indirect
taxes.
ii. Non-Tax Revenue:-
Apart from taxes, governments also receive revenue from other non-tax
sources.
The non-tax sources of public revenue are as follows:-
a. Fees: The government provides variety of services for which fees
have to be paid. E.g. fees paid for registration of property, births,
deaths, etc.
b. Fines and penalties: Fines and penalties are imposed by the
government for not following (violating) the rules and regulations.
c. Profits from public sector enterprises: Many enterprises are
owned and managed by the government. The profits receives from
them is an important source of non-tax revenue. For example in
India, the Indian Railways, Oil and Natural Gas Commission, Air
India, Indian Airlines, etc. are owned by the Government of India.
The profit generated by them is a source of revenue to the
government.
d. Gifts and grants: Gifts and grants are received by the government
when there are natural calamities like earthquake, floods, famines,
etc. Citizens of the country, foreign governments and international
organisations like the UNICEF, UNESCO, etc. donate during
times of natural calamities.
e. Special assessment duty: It is a type of levy imposed by the
government on the people for getting some special benefit. For
example, in a particular locality, if roads are improved, property
prices will rise. The Property owners in that locality will benefit
due to the appreciation in the value of property.Thus, due to public
expenditure, some people may experience 'unearned increments' in
their asset holding. Therefore the government imposes a levy on
them which is known as special assessment duties. Special
assessment is, therefore, like a special tax that government levies
 in proportion to the benefit accruing to property owners to defray
the cost of development. It is a payment made once-for-all by the
owners of properties for increase in the value of their properties
resulting from development activities of the government. In India,
it is called as betterment levy.

(b) Revenue Expenditure

Revenue expenditure is the expenditure incurred for the routine, usual
and normal day to day running of government departments and
provision of various services to citizens. It includes both development
and non-development expenditure of the Central government.
Expenditures that do not result in the creations of assets are considered
revenue expenditure. It is recurring in nature
In general revenue expenditure includes following:-
a. Expenditure by the government on consumption of goods and
services.
b. Expenditure on agricultural and industrial development, scientific
research, education, health and social services.
c. Expenditure on defence and civil administration.
d. Expenditure on exports and external affairs.
e. Grants given to State governments even if some of them may be
used for creation of assets.
f. Payment of interest on loans taken in the previous year.
g. Expenditure on subsidies.

2. Capital Budget
This part of the budget includes receipts & expenditure on capital
account projected for the next financial year. Capital budget consists of
capital receipts & Capital expenditure.
(a) Capital Receipts
Receipts which create a liability or result in a reduction in assets are
called capital receipts. They are non-recurring and non-routine in nature.
A receipt is a capital receipt if it satisfies any one of the two conditions:
(i) The receipts must create a liability for the government. For example,
Borrowings are capital receipts as they lead to an increase in the liability
of the government. However, tax received is not a capital receipt as it
does not result in creation of any liability.
(ii) The receipts must cause a decrease in the assets. For example,
receipts from sale of shares of public enterprise is a capital receipt as it
leads to reduction in assets of the government.

Sources of Capital Receipts:

Capital receipts are broadly classified into three groups:
1. Borrowings:
Borrowings are the funds raised by government to meet excess
expenditure.
Governments borrow funds from:
(i) Open Market (Public): through the sales of bonds and securities.
(ii) Reserve Bank of India (RBI);
(iii) Foreign governments (like loans from USA, England etc.);
(iv) International institutions (like World Bank, International Monetary
Fund).
Borrowings are capital receipts as they create a liability for the
government.
2. Recovery of Loans:
Government grants various loans to state governments or union
territories. Recovery of such loans is a capital receipt as it reduces the
assets of the government.
3. Other Receipts:
These include:
(a) Disinvestment:
Disinvestment refers to the act of selling a part or the whole of shares of
selected public sector undertakings (PSU) held by the government. They
are termed as capital receipts as they reduce the assets of the
government. Government holds ownership in various PSU’s in the form
of equity shares. When the government sells a part or whole of its
shares, it leads to transfer of ownership of PSU’s to the private
enterprises.
(b) Small Savings:
Small savings refer to funds raised from the public in the form of Post
Office deposits, National Saving Certificates, Kisan Vikas Patras etc.
They are treated as capital receipts as they lead to an increase in liability.
(b) Capital Expenditure
Capital expenditure refers to the expenditure which either creates an
asset or causes a reduction in the liabilities of the government. It is non-
recurring in nature. It adds to capital stock of the economy and increases
its productivity through expenditure on long period development
programmes, like Metro or Flyover, expenditure on building roads,
flyovers. Factories, purchase of machinery etc., repayment of
borrowings, etc.
An Expenditure is a capital expenditure, if it satisfies any one of the
following two conditions:
(i) The expenditure must create an asset for the government. For
example, Construction of Metro is a capital expenditure as it leads to
creation of an asset.
(ii) The expenditure must cause a decrease in the liabilities. For
example, repayment of borrowings is a capital expenditure as it leads to
a reduction in the liabilities of the government.

Thus, we see that the budget mirrors projected receipts and expenditures.

Revenue Budget Capital budget

Items of Items of Items of Items of
Receipts Expenditure receipts Expenditure
a) taxes on a) Administrative a) Loans and a) Public Works
income and general services Recoveries
b) taxes on b) Social Services b) Market
b) Construction of
property loans power generation
plants
c) customs c)Economic c) Small c) construction of
duty services Savings roads and railways
d) Union d) Community d) External d) Flood Control
Excise Duty Services Loans Works
e) Non-tax e) Maintenance of e) Other e) irrigation canals
Revenue roads and railways Receipts etc.
f) other
Revenues
Total Total Revenue Total Capital Total Capital
Revenue Expenditure Receipts Expenditure
Receipts

Principles of a Sound Budget

The budget process consists of several broad principles that stem from
the definition and mission of the budget process. They reflect the fact
that development of a budget is a political and managerial process that
also has financial and technical dimensions.
The functions or activities covered by these principles are generally
sequentially ordered, but they can often be performed concurrently to
some extent. Moreover, information obtained from one activity or
function can aid in achieving an earlier one.
1. Establish Broad Goals to Guide Government Decision Making
A government should have broad goals that provide overall direction for
the government and serve as a basis for decision making.
This principle provides for the development of a broad set of goals that
establish a general direction for the government. These goals serve as
the basis for development of policies and programs, including the
service types and levels that will be provided and capital asset
acquisition and maintenance. Goals are developed after undertaking an
assessment of community conditions and other external factors, and a
review of the internal operations of the government, including its
services, capital assets, and management including its services, capital
assets, and management practices. Based on the assessment of current
and expected future conditions, and opportunities and challenges facing
the community and the government, broad goals are established that
define the preferred future state of the community. Other principles
address the development of strategies and allocation of resources to
achieve these goals.
2. Develop Approaches to Achieve Goals
A government should have specific policies, plans, programs, and
management strategies to define how it will achieve its long-term goals.
This principle provides for the establishment of specific policies, plans,
programs, and management strategies necessary for the government to
achieve its long- term goals. While broad goals set the general direction
of a government, it is the policies, plans, and programs that define how
the government will go about accomplishing these goals. As such, the
development of policies and programs must explicitly consider how they
contribute to the achievement of the government's broad goals. Policy
and program goals should relate to broad goals. Measures should be
developed to determine the progress being made by the government in
achieving goals.
3. Develop a Budget with Approaches to Achieve Goals
A financial plan and budget that moves toward achievement of goals,
within the constraints of available resources, should be prepared and
adopted.
Development of a long-range financial plan is essential to ensure that the
programs, services, and capital assets are affordable over the long run.
Through the financial planning process, decision makers are able to
better understand the long- term financial implications of current and
proposed policies, programs, and assumptions and decide on a course of
action to achieve its goals. These strategies are reflected in the
development of a capital improvement plan and options for the budget.
4. Evaluate Performance and Make Adjustments
Program and financial performance should be continually evaluated,
and adjustments made, to encourage progress toward achieving goals.
This principle identifies practices that are needed to monitor and
evaluate the government's progress in meeting financial and
programmatic goals identified in the budget and through its policies and
plans. Based on this review, the government may need to make
adjustments to the budget and to plans and policies if goals are to be
achieved. The review undertaken through this principle feeds back into
goal development and review processes to ensure that goals remain
relevant.
BALANCED AND UNBALANCED BUDGET
Budgets are of two types: Balanced and Unbalanced.
Different Types of Government Budget - Diagram

A. Balanced Budget
A government budget is said to be a balanced budget in which
government estimated receipts (revenue and capital) are equal to
government estimated expenditure.
Balanced Budget
Estimated Govt. Receipts = Estimated Govt. Expenditure
Two main merits of a balanced budget are:
(a) It ensures financial stability and (b) It avoids wasteful expenditure.
Two main demerits are:
(i) Process of economic growth is hindered and (ii) Scope of undertaking
welfare activities is restricted.
According to Adam Smith, public expenditure should never exceed
public revenues, i.e., he advocated a balanced budget. But Keynes and
modern economists do not agree with the policy of a balanced budget.
They argue that in a balanced budget, total expenditure (public and
private) falls short of the amount necessary to maintain full employment.
Therefore, government should increase its expenditure to close the gap
between the expenditure essential for full employment and expenditure
that actually takes place. Ideally, a balanced budget is a good policy to
bring the near full employment economy to a full employment
equilibrium.

B. Unbalanced Budget
The budget in which income & expenditure are not equal to each other is
known as Unbalanced Budget.
Unbalanced budget is of two types:-
1. Surplus Budget
2. Deficit Budget
1. Surplus Budget
The budget is a surplus budget when the estimated revenues of the year
are greater than anticipated expenditures.
Government expected revenue > Government proposed Expenditure.
Surplus budget shows the financial soundness of the government. When
there is too much inflation, the government can adopt the policy of
surplus budget as it will reduce aggregate demand.
Increase in revenue by levying taxes on people reduces their disposable
incomes, which otherwise could have been spend on consumption or
saved and devoted to capital formation. Since government spending will
be less than its income, aggregate demand will decrease and help to
reduce the price level.
However, in modern times, when governments have so many social
economic & political responsibilities it is virtually impossible to have a
surplus budget.

2. Deficit Budget
Deficit budget is one where the estimated government expenditure is
more than expected revenue.
Government's estimated Revenue < Government's proposed
Expenditure.
According to Prof. Hugh Dalton, "If over a period of time expenditure
exceeds revenue, the budget is said to be unbalanced".
Such deficit amount is generally covered through public borrowings or
withdrawing resources from the accumulated reserve surplus. In a way a
deficit budget is a liability of the government as it creates a burden of
debt or it reduces the stock of reserves of the government.
Merits and demerits of deficit budget:
A deficit budget has its own merits especially for developing economy
For example (i) It accelerates economic growth and (ii) It enables to
undertake welfare programmes of the people, (iii) It is a cure for
deflation as it checks downward movement of prices. At the same time.
It has demerits also such as:
(i) It encourages unnecessary and wasteful expenditure by the
government, (ii) It may lead to financial and political instability, (iii) It
shakes the confidence of foreign investors.
The situation of excess demand leading to inflation (continuous rise in
prices) and the situation of deficient demand leading to depression (fall
in prices, rise in unemployment, etc.). A surplus budget is recommended
in the situation of inflationary trends in the economy whereas a deficit
budget is suggested in the situation of recession.
In developing countries like India, where huge resources are needed for
the purpose of economic growth & development it is not possible to
raise such resources through taxation, deficit budgeting is the only
option.
In Underdeveloped countries deficit budget is used for financing planned
development & in advanced countries it is used as stability tool to
control business & economic fluctuations.
BUDGET DEFICIT
When the government expenditure exceeds receipts, the government is
having a budget deficit. Thus the budget deficit is the excess of
government expenditures over government receipts (income). When the
government is running a deficit, it is spending more than its receipts.
The government finances its deficit mainly by borrowing from the
public, through selling bonds. It is also financed by borrowing from the
Central Bank.
Types of Budget Deficits
The different types of budgetary deficit are explained in following
points:-
1. Revenue Deficit:
Revenue deficit is excess of total revenue expenditure of the government
over its total revenue receipts. It is related to only revenue expenditure
and revenue receipts of the government. Alternatively, the shortfall of
total revenue receipts compared to total revenue expenditure is defined
as revenue deficit.
Revenue deficit signifies that government’s own earning is insufficient
to meet normal functioning of government departments and provision of
services. Revenue deficit results in borrowing. Simply put, when
government spends more than what it collects by way of revenue, it
incurs revenue deficit. Mind, revenue deficit includes only such
transactions which affect current income and expenditure of the
government. Put in symbols:
Revenue deficit = Total Revenue expenditure – Total Revenue receipts
The deficit is to be met from capital receipts, i.e., through borrowing and
sale of its assets. A higher revenue deficit is worse than lower one
because it implies a higher repayment burden in future not matched by
benefits via investment.
Remedial measures:
A high revenue deficit warns the government either to curtail its
expenditure or increase its tax and non-tax receipts. Thus, main remedies
are:
(i) Government should raise rate of taxes especially on rich people and
any new taxes where possible, (ii) Government should try to reduce its
expenditure and avoid unnecessary expenditure.
Implications:
Simply put, revenue deficit means spending beyond the means. This
results in borrowing. Loans are paid back with interest. This increases
revenue expenditure leading to greater revenue deficit.
Main implications are:
(i) Reduction of assets:
Revenue deficit indicates dissaving on government account because
government has to make up the uncovered gap by drawing upon capital
receipts either through borrowing or through sale of its assets
(disinvestment).
(ii) Inflationary situation:
Since borrowed funds from capital account are used to meet generally
consumption expenditure of the government, it leads to inflationary
situation in the economy with all its ills. Thus, revenue deficit may result
either in increasing government liabilities or in reduction of government
assets. Remember, revenue deficit implies a permanent burden in future
without the benefit arising from investment.
(iii) More revenue deficit:
Large borrowings to meet revenue deficit will increase debt burden due
to repayment liability and interest payments. This may lead to larger and
larger revenue deficits in future.
2. Capital Deficit:
The excess of capital expenditure over capital receipts measures the
capital deficit.
Capital Deficit = Capital Expenditure – Capital Receipts
3. Fiscal Deficit:
(a) Meaning:
Fiscal Deficit is a difference between total expenditure (both revenue
and capital) and revenue receipts plus non-debt capital receipts like
recovery of loans, proceeds from disinvestment. In other words, fiscal
deficit is equal to budgetary deficit plus government’s market
borrowings and liabilities. This concept fully reflects the indebtedness of
the government and throws light on the extent to which the government
has gone beyond its means and the ways in which it has done so.
In the form of an equation:
Fiscal deficit = Total expenditure – Total receipts excluding borrowings
If we add borrowing in total receipts, fiscal deficit is zero. Clearly, fiscal
deficit gives borrowing requirements of the government. Let it be noted
that safe limit of fiscal deficit is considered to be 5% of GDR .
Fiscal deficit = Total Expenditure – Revenue receipts – Capital receipts
excluding borrowing
A little reflection will show that fiscal deficit is, in fact, equal to
borrowings. Thus, fiscal deficit gives the borrowing requirement of the
government.
Can there be fiscal deficit without a Revenue deficit? Yes, it is possible
(i) when revenue budget is balanced but capital budget shows a deficit or
(ii) when revenue budget is in surplus but deficit in capital budget is
greater than the surplus of revenue budget.
Importance: Fiscal deficit shows the borrowing requirements of the
government during the budget year. Greater fiscal deficit implies greater
borrowing by the government. The extent of fiscal deficit indicates the
amount of expenditure for which the government has to borrow money
Implications:
(i) Debt traps:
Fiscal deficit is financed by borrowing. And borrowing creates problem
of not only (a) payment of interest but also of (b) repayment of loans. As
the government borrowing increases, its liability in future to repay loan
amount along with interest thereon also increases. Payment of interest
increases revenue expenditure leading to higher revenue deficit.
Ultimately, government may be compelled to borrow to finance even
interest payment leading to emergence of a vicious circle and debt trap.
(ii) Wasteful expenditure:
High fiscal deficit generally leads to wasteful and unnecessary
expenditure by the government. It can create inflationary pressure in the
economy.
(iii) Inflationary pressure:
As government borrows from RBI which meets this demand by printing
of more currency notes (called deficit financing), it results in circulation
of more money. This may cause inflationary pressure in the economy.
(iv) Partial use:
The entire amount of fiscal deficit, i.e., borrowing is not available for
growth and development of economy because a part of it is used for
interest payment. Only primary deficit (fiscal deficit-interest payment) is
available for financing expenditure.
(v) Retards future growth:
Borrowing is in fact financial burden on future generation to pay loan
and interest amount which retards growth of economy.
(b) How is fiscal deficit met? (By borrowing).
Since fiscal deficit is the excess of govt. total expenditure over its total
receipts excluding borrowings, therefore borrowing is the only way to
finance fiscal deficit. It should be noted that safe level of fiscal deficit is
considered to be 5% of GDR.
(i) Borrowing from domestic sources:
Fiscal deficit can be met by borrowing from domestic sources, e.g.,
public and commercial banks. It also includes tapping of money deposits
in provident fund and small saving schemes. Borrowing from public to
deal with deficit is considered better than deficit financing because it
does not increase the money supply which is regarded as the main cause
of rising prices.
(ii) Borrowing from external sources:
For instance, borrowing from World Bank, IMF and Foreign Banks
(iii) Deficit financing (printing of new currency notes):
Another measure to meet fiscal deficit is by borrowing from Reserve
Bank of India. Government issues treasury bills which RBI buys in
return for cash from the government. This cash is created by RBI by
printing new currency notes against government securities. Thus, it is an
easy way to raise funds but it carries with it adverse effects also. Its
implication is that money supply increases in the economy creating
inflationary trends and other ills that result from deficit financing.
Therefore, deficit financing, if at all it is unavoidable, should be kept
within safe limits.
Is fiscal deficit advantageous? It depends upon its use. Fiscal deficit is
advantageous to an economy if it creates new capital assets which
increase productive capacity and generate future income stream. On the
contrary, it is detrimental for the economy if it is used just to cover
revenue deficit.
Measures to reduce fiscal deficit:
(a) Measures to reduce public expenditure are:
(i) A drastic reduction in expenditure on major subsidies.
(ii) Reduction in expenditure on bonus, leaves encashment, etc.
(iii) Austerity steps to curtail non-plan expenditure.
(b) Measures to increase receipts are:
(i) Tax base should be broadened and concessions and reduction in taxes
should be curtailed.
(ii) Tax evasion should be effectively checked.
(iii) More emphasis on direct taxes to increase revenue.
(iv) Restructuring and sale of shares in public sector units.
4. Primary Deficit:
(a) Meaning:
Primary deficit is defined as fiscal deficit of current year minus interest
payments on previous borrowings. In other words, whereas fiscal deficit
indicates borrowing requirement inclusive of interest payment, primary
deficit indicates borrowing requirement exclusive of interest payment
(i.e., amount of loan).
We have seen that borrowing requirement of the government includes
not only accumulated debt, but also interest payment on debt. If we
deduct ‘interest payment on debt’ from borrowing, the balance is called
primary deficit.
It shows how much government borrowing is going to meet expenses
other than Interest payments. Thus, zero primary deficits mean that
government has to resort to borrowing only to make interest payments.
To know the amount of borrowing on account of current expenditure
over revenue, we need to calculate primary deficit. Thus, primary deficit
is equal to fiscal deficit less interest payments.
Symbolically:
Primary deficit = Fiscal deficit – Interest payments
(b) Importance:
Fiscal deficit reflects the borrowing requirements of the government for
financing the expenditure inclusive of interest payments. As against it,
primary deficit shows the borrowing requirements of the government
excluding interest payment for meeting expenditure. Thus, if primary
deficit is zero, then fiscal deficit is equal to interest payment.
Thus, primary deficit is a narrower concept and a part of fiscal deficit
because the latter also includes interest payment. It is generally used as a
basic measure of fiscal responsibility. The difference between fiscal
deficit and primary deficit reflects the amount of interest payments on
public debt incurred in the past. Thus, a lower or zero primary deficits
means that while its interest commitments on earlier loans have forced
the government to borrow, it has realized the need to tighten its belt.
5. Budgetary Deficit
Budgetary Deficit is the difference between all receipts and expenditure
of the government, both revenue and capital. This difference is met by
the net addition of the treasury bills issued by the RBI and drawing
down of cash balances kept with the RBI. The budgetary deficit was
called deficit financing by the government of India. This deficit adds to
money supply in the economy and, therefore, it can be a major cause of
inflationary rise in prices.
The concept of budgetary deficit has lost its significance after the
presentation of the 1997-98 Budget. In this budget, the practice of
issuing ad hoc treasury bills as source of finance for government was
discontinued. Ad hoc treasury bills are issued by the government and
held only by the RBI. They carry a low rate of interest and fund
monetized deficit. These bills were replaced by ways and means
advance. Budgetary deficit has not figured in union budgets since 1997-
98. Since 1997-98, instead of budgetary deficit, Gross Fiscal Deficit
(GFD) became the key indicator.
6. Monetised Deficit
Monetized deficit is also known as the ‘net reserve bank credit to the
government’. It is that part of the government deficit which is financed
solely by borrowing from the RBI.
Since borrowings from the RBI can be both short-term and long-term,
therefore, monetized deficit is the sum of the net issuance of short-term
treasury bills, dated securities (that is, long-term borrowing from the
RBI) and rupee coins held exclusively by the RBI, net of Government’s
deposits with the RBI.
Monetised deficit is defined as net increase in net Reserve Bank of India
credit to central government. The rationale for this measure of deficit
flows from the inflationary impact which a budgetary deficit exerts on
the economy.
Since borrowings from Reserve Bank of India directly add to money
supply, this measure is termed monetised deficit. It is obvious that
monetised deficit is only a part of fiscal deficit.

Conclusion
All these budgetary deficits reveal fiscal imbalance. Fiscal imbalance &
budget deficit result in harmful consequences like mounting inflation,
deficit in balance of payment, etc. It has also adversely affect the growth
of the economy. The government must introduce fiscal correction
policies to overcome the deficit budget and fiscal crisis.

DEFICIT FINANCING
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 itself.
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 been used as a
method of financing war expenditure. During the war time, it becomes
difficult to mobilize adequate resources through normal methods of
raising resources Therefore government has to adopt deficit financing.

2. Remedy for depression: - In developed countries deficit financing is

used as an 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 increases
the income and purchasing power of the people. As a consequence, there
will be an increase in the availability of goods and services and the
production and employment levels 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.
Merits of deficit financing:
Following are the important advantages of deficit financing:
1. High level of employment is ensured by the policy of deficit
financing.
2. Unutilized and underutilized resources can be put to best use with the
help of this policy.
3. Additional resources can be mobilized for the economic development
by using this policy.
4. Social and economic over heads can be built up by adopting the
policy of deficit financing.
5. In an underdeveloped country like India, where there is a democratic
set up, the government finds it difficult to create resources through
taxation, because there would be always opposition from the public to
increase taxation.
6. A small dose of deficit financing helps to increase the money supply
and push up demand. This naturally adds to the additional power of the
public. Furthermore, it boosts up demand for goods and services which
in turn leads to increase in production, income and employment.
Adverse effects of deficit financing:
Deficit financing is not free from its defects. 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 and 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. In fact, it is not
possible for the people to maintain the previous rate of saving in the
situation of rising prices.
3. Adverse effect on Investment; - deficit financing affects investment
adversely. When there is inflation in the economy trade unions make
demand for higher wages; for that they go on strikes and lock outs which
decreases the efficiency of Labour and creates uncertainty in the
business which decreases the level of investment of the country.
4. Inequality: - In case of deficit financing income distribution becomes
unequal. During deficit financing, inflationary pressure can be seen in
the economy which makes the rich richer and the poor, poorer. The fixed
wage earners are badly affected and their standard of living deteriorates
thus the gap between the rich and the 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 unfavourable.
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 from the part 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.
Then 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 the
rise in price will only be temporary for about a period. As flow of goods
and services increase, prices will begin 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 within limits it may lead to rise in 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.
Measures to check adverse effects of deficit financing
A persistent deficit policy is, no doubt, dangerous to price stability. The
increased money supply increases the aggregate demand but the supply
of output fails to increase at the same rate and this tends to increase the
prices and thereby leading to inflation. Particularly when the
government resort to deficit financing for non-developmental
expenditures, or when the expenses are made lavishly and in an
unproductive way, inflation would definitely occur, which would harm
the economic progress as a whole.
In order to avoid and check the adverse effects of deficit financing, the
following measures may be taken:
 1. More receipts should be raised either by additional tax revenues or
raising the net returns from the goods and services sold by the
Government or increasing government drafts on domestic savings
or by raising more domestic loans.
2. The money created through deficit financing, should be used for
productive purposes as far as possible.
3. The supply of essential commodities should be maintained at the
same costs so that the adverse effects of inflation on the public can
be minimised.
4. Increasing the volume of foreign loans for securing additional
domestic receipts by government for offsetting its deficits.
5. Effective restrictions on bank credit.
6. Priority should be given to such projects which yield quick results.
Safe limits of deficit financing
The various kinds of repercussions that deficit financing may have on
the budgetary needs of the government and the entire economy, dictate
that it should be used with a big amount of self-discipline, caution and
produce even in the field of economic development. Deficit financing,
like fire, is a good servant but a bad master. Each time it is resorted to, it
has to be judged whether to proceed or not to proceed beyond the
juncture. Therefore, the key to the success of deficit financing lies
mainly in the capable hands that wield it.
There are certain safe limits for deficit financing. The obvious answer is
that deficit financing should not be resorted beyond the point at which it
becomes inflationary. There is actually no formula by which one may
determine the precise quantification of deficit financing that may
probably be taken in a particular country. Its desirability ultimately
depends fundamentally on the way how it is employed. i.e. the amount
and the environment in which it is undertaken and the policies that go
along with it. The safe limit of deficit financing shall, therefore depend
on a multiplicity of factors. Viz., a) the state of the economy; b) the
purpose for which deficit financing is used; c) the extent to which
increase in investment results in an increasing flow of consumer goods;
d) the response of money rate of wages to prices; e) the success with
which additional incomes could be mopped up through taxes and loans;
f) magnitude of deficit financing and its phasing over the time horizon of
the development planning g) the effectiveness of control of prices of
basic necessities during the period of investment; and h) its likely effect
on the demand for imports and the value of exports.

Role of Deficit Financing in the Economic development of India

In developing countries like India, the major problem they face is that of
a population which is growing faster than the rate of capital formation.
To provide full employment to its huge labour force and to undertake
other developmental activities, we need huge amounts of capital. In our
country, there is a shortage of capital and rate of private investment is
also comparatively low. Hence, it is the responsibility of the government
to undertake investment.
Due to low levels of income, and high propensity to consume, aggregate
savings in the economy are low. Investment being inadequate as
compared to national requirements, the level of production, incomes,
savings and thus of investment again cannot increase sufficiently. Since
investment expenditure required for speedy economic development is
too large to be financed through normal sources of revenue, deficit
financing becomes inevitable.
Deficit financing results in creation of new money. The increase in
money supply tends to raise prices because the supply of goods cannot
be increased in the short run in proportion to increase in people’s
purchasing power. As a result of rise in prices, entrepreneurs’ profits go
up and there is an increase in the inducement to invest on their part.
Thus, there will be an increase in investment in the private sector.
Investment increases in the public sector also. Deficit financing puts in
the hands of the government huge amounts of money with which they
launch public enterprises, multipurpose projects and build up essential
infrastructure. All this accelerates economic development. Thus, deficit
financing gives the government command over productive resources
which are utilised more fully and more fruitfully.
In this way, deficit financing stimulates economic development both in
the public and private sector.
In short, deficit financing accelerates economic development by:
1. Building up social and economic overheads.
2. Using unemployed or underemployed resources and surplus labour
more fully.
3. Helping to create additional productive capital and
4. Mobilising additional resources for development.
Deficit financing was given important place in India’s five-year plans,
rather too much reliance on it. The Indian Planning Commission was
however aware of the limitations of deficit financing. It was regarded as
safe to explore all other sources of finance before resorting to deficit
financing. Thus, deficit financing is our last resort of finance. The extent
of deficit financing will be decided only after taking into consideration
the inflation in the economy. Though modest targets were fixed for
deficit financing, the government was forced to exceed the targets. Now
the government and the monetary authorities have started taking steps to
reduce fiscal deficit and deficit financing in our country.
Deficit financing, has for sure, helped in the economic development of
India. But it had its negative effects also.