Q. In India, deficit financing is used for raising resources for (UPSC Prelims 2013)
Answer: economic development
Notes: The correct answer is [A] economic development. Deficit financing is a budgetary tool where the government spends more money than it receives in revenue, covering the gap through borrowing or printing new currency.

• Purpose of Deficit Financing (Statement A is Correct): In a developing economy like India, the government often needs to invest heavily in infrastructure, social welfare, and industrial projects to stimulate growth. Since tax revenues are often insufficient to fund these large-scale investments, the government resorts to deficit financing to mobilize resources for economic development. It acts as a means to increase aggregate demand and utilize underemployed resources.
• Redemption of Public Debt (Statement B is Incorrect): Redemption refers to the repayment of loans. Using deficit financing (borrowing more) to pay off existing debt is generally considered a "debt trap" rather than a strategic use of the tool. While it may happen in fiscal mismanagement, it is not the intended purpose for raising resources via this method.
• Adjusting Balance of Payments (Statement C is Incorrect): The Balance of Payments (BoP) deals with international transactions. Deficit financing is a domestic fiscal tool. In fact, excessive deficit financing can lead to inflation, making exports dearer and imports cheaper, which could actually worsen a BoP deficit rather than adjust it. [Image showing the link between fiscal deficit and balance of payments]
• Reducing Foreign Debt (Statement D is Incorrect): Deficit financing usually involves internal borrowing (from the RBI or the public) or external borrowing. Using it does not reduce foreign debt; rather, if the government borrows from international agencies to cover its deficit, the foreign debt increases.

Risks of Deficit Financing:While it helps in resource mobilization, excessive use of deficit financing can lead to:

1. Inflation: An increase in money supply without a corresponding increase in the supply of goods and services.
2. Crowding Out: High government borrowing from the domestic market can reduce the funds available for private investment.
3. Fiscal Instability: Long-term reliance can lead to a high debt-to-GDP ratio.

In India, the FRBM (Fiscal Responsibility and Budget Management) Act was enacted to set targets for the government to reduce these deficits and ensure long-term fiscal sustainability.