Deficit Financing

Deficit Financing in Pakistan

When the govt expenditure exceeds its income then it takes borrow from the banks and other financial institution to meet the deficit. This borrowing process is called deficit financing.

Reasons for Deficit financing in Pakistan

1. High Defense Expenditure

Pakistan has a high defense expenditure .The policy of high expenditure on defense may result in deficit financing. Pakistan consider the powerful military is matter of existence and therefore they expense heavily on the defense equipment.

 This is obvious that high tech defense equipment cost a lot and this put a huge pressure on the country expenditure. This is not only the defense equipment but to keep a huge army also needs a huge budget for training and payroll.

2. Debt Serving

The other  major reason for deficit financing in Pakistan is the Debt serving. This amount is increasing with each year passing because your debt is increasing with continue debt financing. The budget is supported by borrowing from the bank and next year again the deficit is supported by bank borrowing but this time deficit also include the interest amount on the amount borrowed last year.

 The amount of debt Serving is piling with each passing year in Pakistan.

3. Subsidies 

The govt  of Pakistan is offering different subsidies on different product to control the prices. The govt adopt this practice to control the inflation within country. The political Govt cannot allow a hyper inflationary economy due to public pressure and therefore have no option but to provide subsidies on essential items.

Major sector getting subsidies in Pakistan is energy and fertilizer sector.

4. Inefficient Tax Machinery 

The inefficient tax machinery and culture of not paying tax is also important cause of deficit financing. Some people think tax as burden and not a national responsibility. The other people say why they should pay tax if they are not getting any benefits against those taxes. The element of corruption in tax machinery also play important role in low revenue collection.

5. High Population Growth

The high population growth requires heavy expenditure on infrastructure and other basic facilities like education and health.

6. Loss Making Public Operation

The heavy losses incurred by public cooperation and companies are also a major reason for deficit financing because govt not only provide financial support to those organization but those organization are not contributing toward the tax collection in the country.

Disadvantages Deficit Financing

1. Inflation

The huge expenditure by the Govt will result in inflation in the economy. The inflation in double figure is always alarming and therefore if the corrective measure is not taken the inflation may become uncontrollable and this may create a caustic situation for the economy.

2. Debt Serving

The debt serving will increase day by day and at one stage the govt will have to pay a huge chunk of its revenue in debts serving and it will have limited funds for development projects. There is also a chance of default and if it happens it will have negative impact on the economy of country. Once you are declared defaulter then no one in the world is going to trust you and your international trade will suffer a lot. Therefore it is important to keep the debt within a certain limit .

3.Limited Private Sector Borrowing 

The bank considers it more secure to borrow to govt than to borrow to private sector. The private sector borrowing will be reduced substantially this will have negative impact on the growth and job creation in the economy.  It is proven fact that high private sector is the back bone of the economy. The all developed counties have huge contribution from the private sector. The banks are primarily created to provide financial support and services to private sector but by getting huge borrowing from the bank by Govt will hamper the bank main function.

4. Encourages Imports

The high rate of inflation will make the domestic product expensive that imported product. Therefore people would prefer to use the imported product.  This will not only reduce the demand for the local product but also adversely y effect the balance of trade of the country. This situation may also lead the smuggling of the goods.

How to reduce deficit financing

1. Tax Reforms

This is the best method to control deficit financing to increase your income against your expenditure. But this method can only be applied if there is space for tax broadening is available. This is not a suitable option in case of already high tax economy and a reasonable percentage of GDP is being collected as tax.

The administrative measure should be taken against corrupt tax officer. The Govt should also work on awareness in public about the importance of tax payment. The Govt should also improve the confidence of public by improving the social status of the people so they are motivated to pay the tax.

2. Privatization of Loss Making Public Entities

The loss making public entities must be privatized. This has several advantages for example privatization will not only improve the efficiency of those organization but also bring some revenue to govt to bridge the financial deficit.  The privatization process will also improve the tax collection from those privatized entity.

3. Reducing the Non Development Expenditure

The countries may reduce the non development expenditure on defense. The countries must reassess their military objective and need in the context of the economy. There is great example of Russia that a huge military could not save Russian from the partition. The military establishment must realize that economy is important to serve the military.

4. Control Population Growth

The other important aspect is to control population growth rate. It is not possible for developing countries to allocate huge funds for infrastructure and therefore the other option available is to control population growth rate.