Deficit financing

Also called: Printing money, borrowing from RBI · Topic: Government Budget, Fiscal Policy and FRBM · NCERT: Class 12, Ch 5 "Government Budget and the Economy"

Meaning

Deficit financing means covering a budget deficit by creating new money. In India, this usually means the government borrowing from the RBI.

• Broadly, the term covers any way of filling the gap, including borrowing. In Indian usage and in exams, it means the part paid for with new money.
• It matters because money that the RBI lends to the government is newly created. It raises money supply and can raise prices. So it is the riskiest way to fund a deficit.
• Formula: Monetised deficit = Increase in the RBI's net credit to the government during the year.
• Financing identity (NCERT): Gross fiscal deficit = Net borrowing at home + Borrowing from RBI + Borrowing from abroad. Deficit financing is the "Borrowing from RBI" part of this identity.

Explanation

How it works

• Fiscal deficit (FD) is the government's total spending minus its total receipts, not counting borrowings. It shows how much the government must borrow in a year.

• Formula: FD = Total expenditure − (Revenue receipts + Non-debt capital receipts)

• The government can fill this gap in three ways: borrowing at home, borrowing from the RBI or borrowing from abroad.

• Only borrowing from the RBI creates new money. The chain is:
• The RBI lends to the government.
• New high-powered money enters the economy. High-powered money is the base money the RBI creates: currency plus bank reserves held with the RBI.
• Banks build more loans on top of this base, so the total money supply rises.

• If the supply of goods does not grow as fast, prices rise and you get inflation.

• This is why deficit financing is called "printing money". The RBI does not always print new notes, but it does create new money.

Worked example

• The RBI's net credit to the government rises from ₹10 lakh crore to ₹12 lakh crore in a year.
• Monetised deficit = ₹12 lakh crore − ₹10 lakh crore = ₹2 lakh crore.
• Only this ₹2 lakh crore is deficit financing. The rest of the FD is met by borrowing from the public, banks and abroad, which does not create new money.

The other sources: what deficit financing is NOT

• Net borrowing at home has two parts:
• Directly from the public, through small savings schemes such as PPF, NSC, post-office deposits and Sukanya Samriddhi.

• Indirectly from banks, through the Statutory Liquidity Ratio (SLR). SLR is the share of their deposits that banks must keep in safe assets, mainly G-secs. G-secs (government securities) are bonds the government sells when it borrows.

• Borrowing from abroad: loans from other countries and from bodies such as the World Bank.

• These sources move money that already exists from savers to the government. They do not create new money.

What makes it rise or fall

• It rises when:
• the deficit is large and markets cannot absorb enough bonds, or

• the law allows the RBI to buy bonds directly from the government, as in an emergency.

• It falls when:

• rules bar the RBI from funding the government, or
• the government keeps its deficit low and borrows from the market.

In India

• Institutions: the RBI is the government's banker and the lender here. The Ministry of Finance plans how the government borrows.

• History of RBI financing: 1. Ad hoc Treasury Bills allowed automatic, unlimited monetisation. When the government ran short of cash, it issued them to the RBI, and the RBI had to accept them. 2. 1994: the government and the RBI signed an agreement to phase out ad hoc T-bills. 3. 1 April 1997: ad hoc T-bills ended and Ways and Means Advances (WMA) began. The old ad hoc T-bills were later converted into marketable securities, in 2003-04 [4]. 4. FRBM Act 2003: from 2006-07, the RBI may not subscribe to primary issues of G-secs. A primary issue is the first sale of a new bond by the government. 5. 2018 amendment: direct RBI subscription is allowed when the escape clause is invoked. The escape clause lets the government miss its deficit targets in special situations named in the law. This became a live question in the 2020 pandemic.

• Ways and Means Advances (WMA): short-term advances from the RBI that cover a temporary gap between the government's receipts and payments. They are not meant to fund the deficit itself.

• Under FRBM, WMA is the only allowed form of borrowing from the RBI.
• The RBI fixes the limit in consultation with the government, one half-year at a time.
• The WMA limit for H1 2026-27 (April–September 2026) is ₹2,50,000 crore, announced on 27 March 2026 [2].
• WMA is charged at the repo rate, the rate at which the RBI lends to banks for a short time. Overdraft, which is borrowing beyond the WMA limit, is charged at repo rate + 2% [2].

• The RBI may trigger fresh market loans once the government has used 75% of the WMA limit [2].

• Today the market, not the RBI, funds the deficit. The figures for 2026-27 (BE) are:

• FD is 4.3% of GDP, compared with 4.4% in 2025-26 (RE) and 4.8% in 2024-25 (actual) [3].
• Total borrowings needed are ₹16,95,768 crore [3].
• Net market loans (dated G-secs) are ₹11,73,210 crore, about 69% of FD [3][4].
• Securities against small savings (NSSF) are ₹3,86,772 crore, about 23% of FD [3][4].
• Net external debt is ₹15,385 crore, about 1% of FD [3][4].

Don't confuse with

• Fiscal deficit: this is the government's total borrowing need. Deficit financing, measured by the monetised deficit, is only the part the RBI funds.
• Ways and Means Advances: these are short-term loans that cover temporary cash gaps and must be repaid within the arrangement. Deficit financing funds the deficit itself and adds to money supply.
• Market borrowing: selling G-secs to banks and the public moves existing savings to the government, so no new money is created. Its main risk is crowding out: bond interest rates rise, so private firms find loans costlier. The main risk of deficit financing is inflation.
• Ad hoc Treasury Bills: these were the old tool of unlimited, automatic monetisation. They ended on 1 April 1997. WMA, which has limits, replaced them.

Prelims Hooks

• Monetised deficit = increase in the RBI's net credit to the government. It is not the same as the whole fiscal deficit.
• Ad hoc T-bills ended on 1 April 1997 and were replaced by WMA, following the 1994 agreement between the government and the RBI.
• FRBM Act 2003: the RBI has been barred from buying primary issues of G-secs since 2006-07. The 2018 amendment allows it only when the escape clause is invoked.
• WMA interest = repo rate. Overdraft = repo rate + 2%. The RBI may trigger market loans at 75% use of the WMA limit. The limit for H1 2026-27 is ₹2,50,000 crore [2].
• Trap: the WMA limit is fixed by the RBI in consultation with the government, not by Parliament [2].
• Trap: banks lend to the government indirectly through SLR. That is market borrowing, not deficit financing. The largest source of FD financing is net market borrowing, at about 69% in 2026-27 (BE) [3][4].

Mains Points

• Monetisation vs market borrowing:
• Borrowing from the RBI is cheap and fast. But it adds to money supply and inflation, and it weakens the RBI's independence.
• Market borrowing avoids new money creation. But it pushes up bond yields, so private firms find loans costlier (crowding out).

• The path from ad hoc T-bills to WMA to FRBM shows India choosing market discipline. The 2018 escape clause keeps an emergency option, as the 2020 pandemic debate showed.

• RBI autonomy and inflation control:

• When the RBI cannot refuse to lend to the government, it cannot fully control money supply or inflation.

• Ending automatic monetisation in 1997 gave the RBI more control over monetary policy. The 75% trigger and the higher overdraft rate stop the government from leaning on the RBI [2].

• A cost of avoiding deficit financing:

• Relying on the market and small savings means the government pays market-linked, and often higher, interest.
• Interest payments take 40% of revenue receipts in 2026-27 (BE) [3]. So cutting the deficit itself, not just changing how it is funded, is the lasting answer. This point works well in a GS-III answer on fiscal rules.

Related concepts

• Small savings schemes
• Ways and means advances
• Monetised deficit
• Off-budget borrowing
• Contingent liabilities

Read more

• Financing deficits: borrowing, RBI, small savings and hidden liabilities