How can a deficit budget be financed

 A budget deficit occurs when government expenditure (G) is greater than revenue (T) (G>T). There are several main ways that the Bangladesh government can finance a deficit.

i.      Firstly, the government can borrow funds from the other sectors of the economy. This involves the selling of new Commonwealth Government Securities (CGS) such as treasury bonds through a tender system.

 

This is the preferred government method of raising funds, as it does not add to net foreign debt, because the government is not borrowing from overseas. However, there is a disadvantage to this form of debt financing.

 

When the Federal Government sells CGS it competes with the private sector for domestic savings, creating what is referred to as a “crowding out effect”. A shortage of funds in the domestic market can result and domestic investors may need to borrow funds from overseas. Government borrowing has then, effectively “crowded out” private investment. Private investment may be postponed as interest rates and the cost of credit rise.

 

ii.      The second possible method of financing a deficit is for the Commonwealth Government to sell CGS to the Reserve Bank. This form of borrowing from the Reserve Bank basically means that the government prints money to finance the deficit. The Government has not used this method of deficit financing since the deregulation of the Australian financial market in

1982. This is because it is highly inflationary: when the government spends the money, there is an increase in the money supply; if the economy is near full employment, demand inflation occurs rapidly, as there is too much money chasing a limited supply of goods.

 

 iii.       The third possible method used to finance a budget deficit is for the government to borrow funds from international financial markets. The government has not borrowed from overseas since the late 1980s to finance the deficit. When using this method, the Reserve Bank sells new CGS to overseas buyers, and receives foreign funds that are converted into Australian dollars. This method of financing the deficit adds to foreign debt when interest is paid on the securities (net income component of the balance of payments).

 The government may decide to borrow funds from overseas to reduce the crowding out effect. Under a floating exchange rate such borrowing has no effect on the domestic money supply. However, exchange rates and domestic interest rates can be affected; further, it adds directly to foreign debt.

iv.       The selling of government assets is an alternative method to borrowing that the government can also use to fund a budget deficit. The sale of assets can create a headline budget surplus and reduce the crowding out effect typically caused by the sale of government bonds.