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Updated on June 11, 2012

Deficit Financing In Pakistan

What is deficit financing?.

When a government spends more than what it currently receives in the form of taxes and fees during a fiscal year, it runs in to a deficit budget. When the budget deficit is financed by borrowing from the public and banks, it is called deficit financing.

Deficit financing refers to the borrowing undertaken by the government to make up for the revenue shortfall. It is the best stimulant for the economy in short term. However, in the long term it becomes a drag on the economy and becomes the reason for rise in interest rate

There is no precise definition of the term deficit financing. It is a method used to finance the overall or net budget deficit. Deficit financing is said to have been practiced when the expenditure of the government both development and non- development exceeds its current revenue and capital budget and the deficit is met through government borrowing.

Deficit financing is an important source of capital formation in the developed and underdeveloped countries of the world. In advanced countries, the newly created money is used to finance public investments which increases economic growth. The government invests borrowed money in improving the quality and reliability of infrastructure i, e, railways, roads, air service, social overheads such as schools. hospitals etc. The deficit financing is mostly employed to boost up economic activity in the private sector, raising effective demand for goods and services, increasing employment opportunities etc,. etc.

In developing countries, the governments are faced with persistent deficits in the budgets. They are liberally using the delicate tool of deficit financing for paying back the domestic and foreign loans, meeting the government consumption expenditure etc., Pakistan, here, is no exception to it. It has persistent huge budget deficits and has been resorting to deficit financing since 1950s. Borrowing for budgetary support averaged at Rs. 45.9 billion during 1993-97 . It increased to Rs. 72.5 billion in 1996-97 . It was Rs. 62 billion in 2001-02 Rs. 106 billion in 2004-05 and Rs. 121.2 billion in 2005-06 and 130.9 billion for 2007-08.

Reasons for deficit financing in Pakistan. The main reasons for resorting to deficit financing in Pakistan are as under:

(1) Rise in government expenditures. As the years pass, there is a rapid increase in the government's current expenditure both development and non-development. It has not been able to meet its expenditures from its revenues.

(2) No rule based fiscal policy. There is no effective rule based fiscal policy in the country. Fiscal indiscipline has resulted in the rise of public debt.

(3) Fiscal deficit. The fiscal deficit averaged around 7 percent of GDP in 1990s. The public debt burden continued to increase from 66% of GDP in 1980 to almost 100% by mid 2000. During the last two years, the present Government has succeeded in reducing the overall fiscal deficit to 3.3% of GDP in 2004-05, 3.4% in 2005-06 However, it increased to 4.2% of GDP in 2006-07.

(4) Low savings. The people in Pakistan are consumption oriented. Due to high propensity to consume, the domestic saving rate of about 16% is very low. As such the Government is compelled to use deficit financing as an instrument to cover the receipts expenditures gap.

(5) Rapid population growth. The rapid rat of population growth (1.8%) is swallowing up whatever little economic progress is made. The Government is anxious to speed up the economic development in the shortest possible period of time and is using the method of deficit financing.

Sources of Financing Deficit

There are three methods or sources which are used to finance budgetary deficits in Pakistan. Each method of financing has its own macro economic implications which are discussed in brief.

The methods of deficit financing are:

(1) Bank borrowing

(2) Non-bank borrowing ] Domestic Borrowing.

(3) External borrowing.

(1) Bank Borrowing

The Government meets the deficit in budget by borrowing from the Central Bank of the country in two ways: (1) The Central Bank (SBP) issues new currency notes in the amount borrowed by the Government (2) The Government draws upon the cash balances of the past for meeting the budget deficit. The effect of deficit financing through bank borrowing is that it increases money supply in the country and generally creates inflationary pressure in the economy.

(2) Non-bank Borrowing:

The government of Pakistan is also financing fiscal deficit through non bank borrowing. The funds to meet the deficits in the budget are mobilized through the sale of government. Treasury Bills. Short Term Federal Bonds, Defence Saving Certificate etc. If there is a continuous rise in borrowing through this source. it creates inflationary pressure in the economy, increases domestic interest rates, discourages private investment in the country. The total outstanding domestic debt is Rs. 2523 billion by March, 2007 in Pakistan.

(3) External Borrowing.

T he persistence of large fiscal deficits has forced the government of Pakistan to borrow from overseas. The total foreign debt burden has gone up to $38.8 billion as in March, 2007. The initial impact of borrowing is that it adversely affects the exchange rate. The balance of trade deteriorates. There is also flight of capital from the country. On average, external financing of budget deficit remains one fourth of total financing in Pakistan.

Is deficit financing a useful weapon?

Deficit financing is a delicate fiscal weapon for stimulating economic development. If it is wisely used, it has the following beneficial effects on the economy.

(1) If mobilizes additional resources for economic development.

(2) It helps in utilization of unutilized and under utilized resources of the country.

(3) It helps in building up social and economic overheads.

(4) It helps in ensuring higher level of employment in the country by productive use of resources.

Adverse Effects of Deficit Financing.

(1) The effects of deficit financing on the economy depends upon the method for which it is financed. When the government borrows funds, It competes with the private business borrowers for funds. The additional demand for funds raises interest rate in the money market. As a result, thereof, the private investment is depressed.

(2) In case the deficit financing is financed by printing of notes by the central bank, It creates inflationary impact on the economy, which (a) discourages foreign investment (b) reduces exports (c) increases imports (d) increases inequality in the distribution of income (e) lowers saving rate in the economy and (f) encourages wasteful expenditures.

How to reduce inflationary pressure of deficit financing?

Deficit financing creates inflationary pressure in the economy. If the time lag between the injection of created money into the economy and the completion of development projects is long and the extra demand for goods is not matched by additional output, there is greater inflationary pressure in the economy. In case, the time lag is short, there is then a lesser inflationary effect on the economy. The economists recommend following measures for minimizing the inflationary potential of deficit financing:

1. proper import and export policy. A country should frame its import and export policy in such a way that the supply of essential commodities does not fall and they are provided at reasonable prices in the country.

2. Control on the supply of commodities. The inflationary pressure generated by deficit financing can also be reduced by having an effective control on the supply and prices of essential commodities.

3. Proper allocation of scarce resources. The rise in prices generated by deficit financing can also be controlled by proper allocation of scarce resources of the country. The objectives of development, the priority of the projects, the combination of factors should be carefully planned. The scarce resources, in no case, should be wasted on un-productive and wasteful consumption.

4. Fiscal policy, The inflationary rise in prices can also be controlled or minimized through an anti-inflationary fiscal policy. If a government increases the rates of taxes on luxury goods, reduces its own non essential expenditure, introduces compulsory saving schemes etc., the magnitude of the inflationary pressure can be reduced.

5. Monetary policy. An effective monetary policy can also go a long way in minimizing the inflationary pressure of deficit financing. A government can enforce such monetary measures which discourage the non-essential private investment and encourage the expansion of essential investment.

Summing up, the use of deficit financing for economic development may be likened to fire which if unregulated produces havoc, while regulated, it gives light and warmth.


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    • Amy Becherer profile image

      Amy Becherer 5 years ago from St. Louis, MO

      I appreciate your ability to take a complicated subject and render it digestable. The U.S., as you know, as raised the debt ceiling in order to maintain its efforts to avoid being in default. This serves as a temporary fix, much like you have described. It seems the government mirrors the poor philosophy of so many Americans drowning in credit card debt. I understand that the enormity of government is beyond the average family responsibilities, but I believe the same simple philosophy I live by, in avoiding living above my means, is the only principle that maintains a solid balance. However, this requires discipline in being able to distinguish between necessity and excessive consumerism based on "want" instead of "need". In the end, it is far less painful to walk away from what we want because we cannot afford it than not being able to feed ourself or our families. Robbing Peter to pay Paul is not sustainable. Thank you for your excellent, informative article.

    • lionel1 profile image

      lionel1 5 years ago

      Interesting. Thanks.

    • profile image

      thanksabunch 5 years ago

      I like this... good work and very helpful...

    • profile image

      hubab 3 years ago

      good efforts and quite helpful....

    • profile image

      khang 3 years ago

      its soo much help me in my prisention thankx a lit

    • profile image

      red 2 years ago

      Its too much helpful for us

    • profile image

      Yasmin 14 months ago

      Complicated subject made very easy . Thanx

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