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Macroeconomics: Planned expenditure by a government to put more money into the economy than it takes out by taxation, with the expectation that increased business activity will bring enough additional revenue to cover the shortfall. Also called deficit spending. 2. Microeconomics: Debt financing to cover excess of expenditure over income.

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 under developed 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 1950's. Borrowing for budgetary support averaged at Rs. 45.9 billion during 1993-97 . It increased toRs. 72.5 billion in 199697 . It was Rs. 62 billion in 2001-02 Rs. 106 billion in2004-05 and Rs. 121.2 billion in 200506 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 1990's. The public debt burden continued to increase from 66% of GDP in 1980 to almost100% 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% in2005-06 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 antiinflationary 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.

Budget deficit: A financial situation that occurs when an entity has more money going out than coming in. The term "budget deficit" is most commonly used to refer to government spending rather than business or individual spending. When it refers to federal government spending, a budget deficit is also known as the "national debt." The opposite of a budget deficit is a budget surplus, and when inflows are equal to outflows, the budget is said to be balanced.

Crowding Out Effect

A budget deficit can cause the government to increase its reliance on borrowing from foreign sources. As this happens, future budgets can place more emphasis on loan repayments and less emphasis on savings and investment. This chain reaction, called the crowding out effect, can eventually lead to a situation where the federal government allocates less money to investments, such as public education and the highway system, placing more of a burden on state, county and local governments.

Future Debt Burden

An often-cited reason for reducing the budget deficit is the burden it places on future generations. Since deficits tend to increase borrowing, which accrues interest over time, the current generation tends to reap the benefits of the borrowing and a future generation gets the bill. If the attitude of temporarily covering financial problems and leaving the next generation with the damage were to continue over several generations, the nation could find itself in a situation where it could not possibly climb out of its debt.

Tax Hikes

To fund short-term measures to correct budget deficits, there must be reduced government spending or increased taxes. This can create a situation where people pay more taxes for fewer government services, which can cause internal political problems for the nation. As the stewards of citizens' tax money, government officials owe it to the people to manage their money wisely, ensuring that federal, state and local expenditures consistently come in below their budgets.

Political Ramifications

One strong advantage of a budget surplus is the ability to tap sources of money for emergencies. Unplanned expenses for things like natural disaster relief and military emergencies can incur large, shortterm expenses. If the federal government maintains a budget deficit, it will likely need to look to foreign sources of capital to cover emergencies. Not only does this increase the cost of government investment by adding interest charges into the mix, it incurs political "debts" that may be called in sometime in the future.

Whether government deficits are good or bad cannot be decided without examining the specifics. Just as with borrowing by individuals or businesses, it can be good or bad. If the government borrows (runs a deficit) to deal with a severe recession (or depression), to help self-defense, or spends on public investment (in infrastructure, education, basic research, or public health), the vast majority of economists would agree that the deficit is bearable, beneficial, and even necessary. If, on the other hand, the deficit finances wasteful expenditure or current consumption, most would recommend tax cuts to stimulate private investment, transfer cuts, and/or cuts in government purchases to balance the budget.

Deficits weaken the U.S. dollar because when the U.S. pays people or spends money without taking
it from them it has in effect increased the amount of dollars in the country but not increased the amount of goods. This would be like inflation, except that the U.S. must borrow money from treasury bond holders, some of them foreigners, to pay its debts. The interest we pay to foreigners gives them some of our money. Since they have some of our money now but the value of their economy is not greater than before, their money now is worth the value of our money and the value of theirs. Since they now have a lot of money chasing a small amount of goods, and since we have the opposite situation, they are now encouraged to spend in our country. So deficits are good for exports because we get their valuable money when we sell them things. But they are bad for imports because our less valuable money wont buy us as much over there. To review, deficits=weak dollar, and surpluses equal strong dollar. Well, in reality there isnt much difference Keynesian Effect Following John Maynard Keynes, many economists recommend deficit spending to moderate or end a recession, especially a severe one. When the economy has high unemployment, an increase in government purchases creates a market for business output, creating income and encouraging increases in consumer spending, which creates further increases in the demand for business output. (This is the multiplier effect). This raises the real gross domestic product (GDP) and the employment of labour, and if all else is constant, lowers the unemployment rate. (The connection between demand for GDP and unemployment is called Okun's Law.) Cutting personal taxes and/or raising transfer payments can have similar expansionary effects, though which method has a better stimulative economic effect is a matter of debate.[citation needed] The increased size of the market, due to government deficits, can further stimulate the economy by raising business profitability and spurring optimism, which encourages private fixed investment in factories, machines, and the like to rise. This accelerator effect stimulates demand further and encourages rising employment. Increase in government payroll has been shown to depress the economy in the long run.[citation needed]

Similarly, running a government surplus or reducing its deficit reduces consumer and business spending and raises unemployment. This can lower the inflation rate. Any use of the government deficit to steer the macro-economy is called fiscal policy. A deficit does not simply stimulate demand. If private investment is stimulated, that increases the ability of the economy to supply output in the long run. Also, if the government's deficit is spent on such things as infrastructure, basic research, public health, and education, that can also increase potential output in the long run. Finally, the high demand that a government deficit provides may actually allow greater growth of potential supply, following Verdoorn's Law. There is, however, a danger that deficit spending may create inflation - or encourage existing inflation to persist. (In the United States, this is seen most clearly when Vietnam-war era deficits encouraged inflation.) This is especially true at low unemployment rates (say, below 4% unemployment in the U.S.). But government deficits are not the only cause of inflation: it can arise due to such supply-side shocks as the "oil crises" of the 1970s and inflation left over from the past (inflationary expectations and the price/wage spiral). If equilibrium is located on the classical range of the supply graph, an increase in government spending will lead to inflation without affecting unemployment. There must also be enough money circulating in the system to allow inflation to persistso that inflation depends on monetary policy. In other words, without any discretionary policy changes, the Budget Balance will vary in a pro-cyclical manner over the course of the business cycle. When the economy is weak tax revenue falls and welfare payments rise and so the Budget Balance moves towards deficit (or an increasing deficit). When the economy is stronger tax revenue rises and welfare payments fall and the Budget Balance becomes increasingly positive. Automatic stabilisers attenuate the amplitude in the business cycle by expanding the budget in a recession and contracting it in a boom.

Ok, so when the govt takes your money in the form of taxes they do not spend it all immediately. They have to put it into treasury bonds or some other security, but mostly into treasury bonds. A treasury bond is an IOU which says that if you give me so much money now, then i will pay you that money with interest at a certain time in the future. Anyone in the world can buy treasury bonds, including the U.S. govt. The interest rate of treasury bonds is very low, because it is not a risky investment. People are sure the U.S. government will pay them back. When the U.S. government spends money faster than it can take in, then we have a budget deficit. When it takes in money faster than it spends it, then we have a budget surplus. So, when the U.S. govt is running a surplus, it puts money into treasury bills. This means that it can collect interest from itself on its own investment when it takes that money out to spend it. The U.S. government wants to be able to pay its workers, so they have to keep enough money in treasury bills to do so. When they are running a deficit, they have to raise the interest rate of the bond to attract investors into buying its bonds and thereby lending uncle sam money.

Data does not show a correlation between budget surpluses and low interest rates. The democrats will tell you that running a budget deficit causes the U.S. to raise treasury rates, which absorbs saving from the private sector. This lack of saving shrinks the supply of credit and deprives our system of investment capital. This would be true if the amount of private funds in this country didnt add up to about 50 trillion dollars, which is such a huge number than the small deficits or surpluses dont affect it much. This effect is called crowding out. Deficits weaken the U.S. dollar because when the U.S. pays people or spends money without taking it from them it has in effect increased the amount of dollars in the country but not increased the amount of goods. This would be like inflation, except that the U.S. must borrow money from treasury bond holders, some of them foreigners, to pay its debts. The interest we pay to foreigners gives them some of our money. Since they have some of our money now but the value of their economy is not greater than before, their money now is worth the value of our money and the value of theirs. Since they now have a lot of money chasing a small amount of goods, and since we have the opposite situation, they are now encouraged to spend in our country. So deficits are good for exports because we get their valuable money when we sell them things. But they are bad for imports because our less valuable money wont buy us as much over there. To review, deficits=weak dollar, and surpluses equal strong dollar. Well, in reality there isnt much difference, but for this paper that is what you must say.