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What is Budget Deficit? Discuss the Methods of financing a budget deficit.

Posted by Ripon Abu Hasnat on Thursday, December 3, 2015 | 0 comments

Meaning of Budget Deficit:
Budget deficit is a status of financial health in which expenditures exceed revenue. The term "budget deficit" is most commonly used to refer to govt. spending rather than business or individual spending. When referring to accrued federal govt. deficits, the term "national debt” is used. The opposite of a budget deficit is a budget surplus, & when inflows = outflows, the budget is said to be balanced.

Methods of financing a budget deficit:

(i) Borrowing from the private sector - This refers to the govt. borrowing funds from the private sector. Under this system, the Treasury issues securities & govt. bonds to investors. These govt bonds are marketed through the tender system (a type of auction) & are bought in lots of $100000. They are sold to institutions that offer to buy them at lowest interest rate. The key advantage of this method is that the govt. can always be certain of fully financing the deficit.

(ii) Monetary financing (borrowing from the Reserve Bank) - This is also referred to as 'monetizing the deficit' and involves the govt. borrowing directly from the RB rather than private investors. This method is not preferred as it amounts to printing money in order to finance the deficit. This results in an increase in money supply and therefore inflationary pressures.
(iii) Overseas financing - To finance its deficit, the govt. may borrow money from overseas lenders. Although it has the benefit of avoiding the crowding out effect, it has not been used since the 1980s because it adds to foreign debt.

(iv) Selling Assets - Another alternative to financing part of the deficit is selling government assets such as shares in Government enterprises. The sale of assets can create a headline budget surplus however it is not sustainable as it can only be used on a ‘one off’ basis. Although this form of financing a budget deficit may reduce the crowding out effect, it is important to note that the demand for funds from the domestic savings pool may remain the same as borrowing from the private sector. Instead of the govt. borrowing funds, the asset purchasers need to borrow the funds to finance the asset purchase.