India resorted to deficit financing, then largely financed through Reserve Bank's books either by printing more money or use of its foreign exchange reserves, right from the early years of planned economic development. However, our planners did not factor in the impact of deficit financing on inflation. But with large foreign exchange reserves, they were confident of the government's ability to manage the supply-side of the economy.
For much of the 1950s, the Bank was part of this consensus. Although the impact of deficit financing on prices had aroused concern already in 1951-52 , price stability did not return as a major cause of worry at the Bank until the mid-50 s. Besides, the Bank recognised the need for any plan to go beyond what available resources dictated, even if some part of the additional investment had to be financed through additions to money supply.
Ironically, despite the first plan document, highlighting the important role of the central bank, the Reserve Bank also took a rather modest and self-effacing view about its own part in the planning process during these years, insisting that while it was entitled to be consulted by the government regarding the dimensions of the plan effort, the final decisions rested with the latter.
One of the volumes of RBI's history notes that the central bank was not given sufficient time to consider the first Five-Year Plan, the plan document arriving in Bombay only towards the close of October 1952. Any contribution the Bank made to the first plan document appears to have been cosmetic , rather than substantial, with the Governor B Rama Rau, for instance, choosing merely to object to the plan document's suggestion that 'real democracy' implied the 'equality of incomes' .
But in the mid-50 s, the central bank started warning the government about the impact of deficit financing on inflation. In the last 15 years, with India adopting a more market-driven approach to development, and even the concept of deficit now not including monetisation, the central bank still continues to warn the government over the dangers of high fiscal deficit on the conduct of monetary policy."
Deficit Financing is merely an accounting trick and uses the future savings for present lavish spending!MM Singh is misusing this,for Divestment out of India's PSUs,even the profit-making ones,like the recent[yesterday] stake sales in ONGC.This is equivalent to selling the Family Silver,at good times,and inviting bankruptcy,as there will be no reserves to fall back upon during financial crises. Divestment may also cause corruption,as funds may be diverted.
The remedy is "Surplus Financing".the Budgeted Expenditure should be below the expected revenue and the Government should NOT borrow from the RBI.