Deficit Financing 

#GS3 #Economy 

Reserve Bank Keeps Doors Open For Deficit Financing. Guarded transfer of dividends by the Reserve Bank of India to the government on Friday has opened the door for deficit monetization as the government prepares to unveil its second fiscal stimulus package amid growing concerns over economic revival. 

  • In its 584th central board meeting, RBI decided to transfer ₹57,182 crore as surplus to the government for the accounting year ended 30 June, slightly less than the ₹60,000 crore budgeted by the government for FY21.  
  • The fresh transfers are a fraction of the record ₹1.76 trillion that the RBI had transferred to the government in the year-ago, including ₹1.23 trillion as dividend and ₹52,640 crore as a transfer from contingent reserves. 
  • A government official with knowledge of the internal deliberations at RBI’s board meeting said central bank officials gave a lot of information on how RBI lost out on its investments in the international market during the last accounting year, which impacted the dividend amount.  
  • RBI (July-June) and finance ministry (April-March) have been following different accounting years, but the central bank has now agreed to synchronize its financial year with that of the government in tune with the Bimal Jalan panel recommendations.  
  • Subsequently, RBI’s 2020-21 accounting year will be for nine months from 1 July 2020 to 31 March 2021. Thereafter, financial years of both the Centre and the central bank will start on 1 April. 

What is Deficit Financing  

  • 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. 
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