As India gears up for the Union Budget 2026, one term frequently discussed is "deficit financing." Understanding this concept is particularly crucial for developing countries like India, where strategic fiscal policies are essential for sustainable growth. Finance Minister Nirmala Sitharaman is expected to present the budget for FY27 on February 1, 2026.

Deficit financing arises when a government's total expenditure exceeds its total revenue, excluding borrowings. To address this gap, the government resorts to borrowing funds or creating new money. This practice is common in developing economies as a way to stimulate economic growth and address developmental needs.

How Deficit Financing Works

When a government's income from sources like taxes and fees is insufficient to cover its planned expenditure, it has several options:

• Borrowing from the Market: This involves internal borrowing through the issuance of government bonds and Treasury Bills.
• Borrowing from External Sources: Funds can be sourced from foreign governments or international organizations.
• Borrowing from the Central Bank: In some instances, this may lead to the printing of new currency. However, it's important to note that prior to 1997, deficit financing via money printing was common in India, but this practice has largely been discontinued.

Importance for Developing Countries Like India

Deficit financing is a crucial tool for developing economies for several reasons:

• Economic Growth and Development: Developing countries often require massive investments in infrastructure, health, education, and rural development, which the private sector cannot fully support. Deficit financing enables the government to bridge this investment gap and stimulate economic growth.
• Public Investment: Many essential infrastructure projects, such as highways, irrigation systems, and power plants, have long gestation periods and may not attract sufficient private investment. Government intervention through deficit financing becomes vital in these areas.
• Counter-Cyclical Fiscal Policy: Deficit financing allows governments to implement counter-cyclical fiscal policies by increasing spending during economic downturns and reducing spending or raising taxes during booms, which helps stabilize the economy.
• Compensating for Insufficient Tax Revenues: Deficit financing becomes essential to meet expenditure needs.
• Funding Welfare and Managing Emergencies: It helps maintain welfare schemes, subsidies during economic distress, and manage unforeseen events like natural disasters or pandemics.

Potential Risks

While deficit financing can be a powerful tool, it also carries inherent risks:

• Inflation: Printing too much money or a sharp expansion of the money supply can lead to a rise in the prices of goods and services. This inflation can erode purchasing power, especially for lower- and middle-income households.
• Increased Production Costs: Inflation can also increase production costs, potentially deterring investment and widening economic inequality if overused.

India's Fiscal Outlook

The Indian government aims to reduce the fiscal deficit to 4.4% of GDP for the fiscal year 2025-26. While pursuing this target, the government also plans to shift to debt-to-GDP as the primary benchmark for fiscal policy starting in 2026-27, aiming to reduce debt to 50% of GDP by March 31, 2031.

Budget 2026 Expectations

As India moves towards its "Viksit Bharat" vision, Union Budget 2026 is a critical opportunity to accelerate economic transformation. Expectations include tax reforms, incentives for emerging sectors, and measures to strengthen India's economic foundation. The budget is expected to focus on infrastructure, digital progress, employment creation, and sustainable growth.

The Union Budget 2026 will play a pivotal role in shaping India's economic trajectory, and understanding the nuances of deficit financing is crucial for informed discussions and assessments of the government's fiscal strategy.