Types of deficit and deficit financing

1. The four deficits

1. Revenue deficit (RD) = Revenue expenditure − Revenue receipts. It shows that the government is borrowing to meet current expenses (salaries, interest, subsidies), so borrowed money is consumed rather than invested. A revenue deficit means dissaving by government.
2. Fiscal deficit (FD) = Total expenditure − (Revenue receipts + Non-debt capital receipts). Non-debt capital receipts are recoveries of loans and disinvestment proceeds. The fiscal deficit equals the government’s total borrowing requirement for the year. It is the most important single indicator of fiscal health and is usually expressed as a percentage of GDP.
3. Primary deficit (PD) = Fiscal deficit − Interest payments. It shows borrowing needed for purposes other than paying interest on past debt, so it measures the fiscal stance of the current year. A zero primary deficit means the government borrows only to pay interest.
4. Budgetary deficit = Total expenditure − Total receipts (revenue plus capital receipts). In India this gap was met by issuing ad hoc treasury bills to the RBI, that is, by creating money. Ad hoc treasury bills were discontinued from 1 April 1997 and replaced by Ways and Means Advances for temporary mismatches, so the concept is no longer used in Union Budget documents.

Also met in Indian documents: effective revenue deficit = Revenue deficit − grants for creation of capital assets (introduced in the 2011–12 Budget), and monetised deficit = the part of the fiscal deficit financed by net RBI credit to government.

2. A worked example

Check: the fiscal deficit (165) equals borrowings and other liabilities (165), as it must. Of the borrowing, 80 goes to meet the revenue deficit; only 85 finances capital formation. If the government could raise only 140 by borrowing from the market, the remaining gap of 25 would be the budgetary deficit in the old sense, to be met by the RBI.

3. Deficit financing: meaning

The term has two senses.

• Western sense: financing a budget deficit by borrowing from the public (including banks), so that spending exceeds tax revenue. Keynes advocated it to fight depression.
• Indian sense: the Planning Commission (First Five Year Plan) used it to mean the direct addition to gross national expenditure through budget deficits, financed by borrowing from the central bank and drawing down cash balances. In effect it means the creation of new money to cover the deficit. Borrowing from the public is not deficit financing in this sense because it only transfers existing purchasing power.

4. Objectives

1. Financing economic development when taxes and borrowing are insufficient, as in the early Five Year Plans.
2. Recovery from depression by raising effective demand (Keynes).
3. War finance and emergencies.
4. Mobilising idle resources and surplus labour.
5. Capital formation through forced saving: rising prices reduce consumption of fixed-income groups, releasing resources for investment.
6. Raising employment through public works.

5. Types (methods) of deficit financing

• Borrowing from the central bank against government securities or treasury bills (monetisation).
• Drawing down accumulated cash balances of the government.
• Issue of new currency by the government itself.
• Borrowing from commercial banks, which may expand credit (counted in the wider sense).

By purpose, textbooks also distinguish deficit financing for war, for recovery from depression, and for economic development.

6. Effects on a developing economy

Favourable

• Finances capital formation and infrastructure.
• Raises employment and output where idle capacity exists.
• Mild inflation may raise profits and encourage investment.
• Forced saving transfers resources to investment.

Adverse

• Inflation. In a developing economy supply is inelastic (agriculture, bottlenecks), so extra money raises prices more than output. This is the most serious effect.
• Inequality. Wage earners and fixed-income groups lose; traders and profit earners gain.
• Distortion of investment toward speculation, gold and real estate.
• Balance of payments deterioration as imports rise and exports become dearer.
• Inflation spiral raising the cost of the very projects it finances.
• Loss of confidence in the currency.

7. Limits and safeguards

Deficit financing is safe only within limits set by the rate of growth of output and the community’s demand for extra money balances. It should be used for productive projects with short gestation, accompanied by measures to increase supply of essential goods (food stocks, imports), price controls where needed, and taxation to mop up excess purchasing power.

Indian practice now restricts it sharply. Automatic monetisation through ad hoc treasury bills ended in 1997. The FRBM Act, 2003 prohibited the RBI from subscribing to primary issues of government securities from 2006–07, except in specified circumstances, and later amendments allow deviation from fiscal targets only on grounds such as national security, war, national calamity, collapse of agriculture or structural reforms. Fiscal deficits are now financed mainly through market borrowing.

How this is examined

Essays: “Define deficit financing. Explain its effects on developing economy” (January 2026, 80-mark); “What is deficit financing? Explain its importance and limitations” (June 2025); “Explain primary, fiscal and budgetary deficit” (January 2026); “role of deficit financing in economic development of India” and “types of deficit financing” (August 2024). Short notes: “Objectives of deficit financing” (January 2026, 100-mark), “Types of deficit financing” (June 2025), “Limitations of deficit financing” (August 2024), “Primary deficit and fiscal deficit” (October 2023). Write each deficit as a formula with one line on what it signifies; a small numerical like the one above shows the examiner you can apply them.