Government Borrowing and Resource Mobilization for Economic Development

Government borrowing is another fiscal method by which savings of the community may be mobilised for economic development. In developing economies, the Governments resort to borrow­ing in order to finance schemes of economic development. Government or what is also called public borrowing becomes necessary because taxation alone cannot provide sufficient funds for economic development. Besides, too heavy taxation has an adverse effect on private saving and investment.

It may be noted that when there is fiscal deficit (i.e. budget deficit). It can be financed in two ways. First, by borrowing by the Government from the market and this borrowing leads to the increase in public debt. Borrowing as a means to finance the budget deficit is therefore also called debt-financing of budget deficit.

Under borrowing the government issues bonds and sells it to the public. Generally, sale of interest-bearing bonds to the public is indirect through financial intermediaries such as banks. Banks buy the bonds floated by the government with the currency deposits of the public.

Therefore, debt- financing of budget deficit is also known as bond-financing of budget deficit. With the borrowed money in this way the government is able to expand its expenditure but at the same time it adds to public debt which has both short-run and long run consequences.


It may also be noted that budget deficit also comes about when taxes are reduced, keeping government expenditure constant. This type of budget deficit can also be financed through incurring debt by selling bonds to the banks or public. The government has not only to pay annually interest on borrowed funds but has also to pay back the principal sum borrowed for which it may levy higher taxes in future.

The Keynesians have emphasised the expansionary effect of debt-financing of government ex­penditure or budget deficit. In the Keynesian model with a fixed price level, the increase in govern­ment expenditure through use of borrowed money causes an upward shift in aggregate expenditure (C+I+G) curve.

If the economy is working at less than full-employment level of national income so that output gap exists in the economy, the increase in debt-financed government expenditure will bring about expansion in output or income. With the increase in income at the given tax rate, tax revenue collected will rise which will over time reduce the budget deficit or even ultimately eliminate it so that budget becomes balanced.

However critics have pointed out that debt-financed government expenditure is largely offset by the crowding-out effect of debt financing on private investment. The crowding-out effect on private investment takes place in a variety of ways.


First, it has been pointed out that government’s borrowing funds to finance budget deficit will lead to the increase in demand for lendable funds which will cause the rate of interest to rise. The rise in interest rate will cause private investment to decline. Thus debt- financed increase in government expenditure crowds out private investment.

According to this view, due to crowding-out effect on private investment net expansionary effect of increase in government expenditure is negligible. On the other hand, the society will have to bear the burden of increase in public debt as a result of debt-financed expansion in government expenditure.

If budget deficit arises due to reduction in taxes, keeping government expenditure constant, this will also lead to rise in interest rate and will therefore cause crowding-out effect on private investment. This happens be­cause reduction in taxes stimulates consumption expenditure of the people which reduces savings. The decline in savings causes interest rate to rise resulting in fall in private investment.

Government borrowing takes two forms:


(a) Market loans and

(b) Small savings.

In the case of market borrowing, the Government sells to the public negotiable Government Securities of varying terms and duration and treasury bills. For financing capital projects long-term Government bonds are floated in the capital market.

This form of public borrowing is more important for mobilising resources for development. The treasury bills which represent short-term borrowing are intended to meet only the current Government expenditure. New bonds may be issued for meeting old maturing bonds.


The small savings represent public borrowing which are not negotiable and are not bought and sold in the capital market. For mobilising small savings, various types of saving certificates are issued, e.g., National Savings Certificates, National Development Certificates, Rural Development Bonds, Postal Certificates and Postal Accounts, Compulsory deposits, etc. A widespread campaign is necessary to attract small savings.

Borrowing is the quickest mode of raising funds:

Tax finance is not so expeditious because passing of tax laws, assessment of taxes based on those laws and their collection involves consider­able delay. Besides, public debt does not involve any burden if it is devoted to productive works.

The subscribers to Government loans are able to find remunerative investment whereas the Govern­ment can pay the principal and interest out of the income yielded by investment financed from loans. Thus public borrowing is not only necessary but also desirable.

There is another advantage in Government borrowing. Government borrowing is anti-infla­tionary. The underdeveloped countries are victims of inflation since they have to resort to deficit financing for finding funds for economic development.

Since deficit financing is inflationary, public borrowing is preferable to deficit financing. Public borrowing mops up the surplus purchasing power with the people. It thus checks consumption and so a rise in prices. At the same time idle balances are absorbed in productive activity.

Public borrowing generates additional productive capacity:

The funds raised by public bor­rowing can be utilised for building up economic infrastructure for the economy through schemes for the development of irrigation, transport, power and communication. They can help also in building up of the agricultural and industrial base of the economy.

All such investments facilitate further economic growth. There is no doubt, therefore, that the public borrowing plays a very useful and important role in accelerating economic development of underdeveloped economies. Public debt promotes saving and investment, the two most crucial determinants of economic growth.

But there exist a number of obstacles which hinder the success of borrowing policy in develop­ing countries. In many such countries, there are no organised money and capital markets and in those where such markets exist, they constitute a very small proportion of total money market of the country. There may not, besides, exist any organic relationship between the organised and unorganised part of the money market.

Moreover, the resources of the organised money market may be too inadequate to fulfill the needs both of the private and public sectors. Further, in the financial market the competition for funds between the government and the private sector will raise rate of interest and this will have a highly disincentive effect on the expansion of investment in the private sector.

More borrowing by the Government leads to the rise in market rates of interest. The higher interest rates tend to reduce private investment. Therefore, it is often asserted that the higher borrowing target by the Govern­ment ‘crowds out’ private investment.

In India the rates of interest on loans (on bonds or securities) of Government have been raised quite substantially. Since banks and others prefer to invest in Gov­ernment securities because they are safe (i.e., riskless). This has reduced funds for private invest­ment. ,

For the success of government’s borrowing policy, it is necessary that financial institutions be developed and extended into the rural areas of the economy in order to inculcate the habit of thrift in the population and to mobilise for productive purposes the amount of savings originating in this sector. Besides, for the mobilisation of savings it will be necessary to check and regulate the diver­sion of savings into unproductive investment such as real estate, gold and jewellery and inventory accumulation.

Suitable techniques of borrowing must also be devised. For example, bonds issued by the Gov­ernment should be adjusted to the preferences of the general public; bonds of large denomination and long maturity may be offered to the institutional investors, whereas those of small denomination and short maturity may be reserved for the non-institutional public.

If properly devised and con­ducted small savings campaign can mobilise a sizable amount of resources. Further, the mobilisation of the hoardings of gold and jewellery through government programmes constitutes a highly desir­able source of resource mobilisation. Of course, suitable techniques of public borrowing for the mobilisation of these resources have to be evolved.

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