Deficit financing leads to crowding out

When the government takes initiatives to finance budget deficit from the banking sector, it is likely to distort the overall demand and supply of loanable funds. Consequently, it will shift the aggregate demand of the loanable fund and thus result in a hike in the interest rate as the government covers the lion's portion of the demand segment. Therefore, the government's decision to finance the gap between its revenue and expenditures from the banking sector will eventually put the private sector away from the assistance of banking sector, or more specifically, clutch their prospect of getting loans.
During the period of expansionary fiscal policy, governments usually expend more than their revenue generation. Budget deficit has been a common phenomenon in the history of Bangladesh's economy since its inception. No wonder, the new budget for FY 2016-17 burdened with a huge deficit was announced on June 2, 2016 by the finance minister AMA Muhith.
 The projected budget for the imminent fiscal year is BDT 3,406 trillion which is about 15 per cent higher than that of the previous fiscal year. On the other hand, revenue collection is estimated at about BDT 2.48 trillion which was about 2.14 trillion in the last fiscal year. Accordingly, the budget deficit of FY 2016-17 is projected approximately at BDT 0.923 trillion which is about 6.58 per cent higher than that of last fiscal amounting to nearly BDT 0.866 trillion. To meet the gap between the estimated budget and the revenue collection, the government has planned to increase its dependency on bank loan. But the question lies how government finances the consequential budget deficit. The way the government attempts to fill the gap affects the overall economy. Governments of every nation have a number of sources open before them to finance the gap. Every source has its unique effect on the overall economy. Government's overspending has some powerful impacts on the economy. Level and extent of government budget expenditure is not the concern but the fact is how it is supposed to be funded. If there is a budget deficit, the government has the option to finance it through domestic or foreign sources, or by borrowing from financial markets.
Subsequently, the government withdraws money from the domestic financial market to finance its deficit, which trims down national savings with the eventual shrinking in supply of loanable funds. Another way is to search for financing deficit could be through borrowing from commercial banks. When the government borrows money to meet up these shortfalls, there would be the unintended fallout known as crowding out.
High government expenditure stimulates high consumption and increase in aggregate demand. When government as a part of its fiscal policy increases government purchase, there will be the inevitable spiralling in aggregate demand.
Government's financing of major part of the deficit through banking sector will squeeze the access of private sector in the banking system. Without grant about 38.7 per cent of the deficit will be financed by foreign loan whereas about 39 per cent through bank loan. Consequently, given the level of demand of loanable fund, government's borrowing from banking sector will contribute to interest rate hike, which will ultimately hit down the level of investment in the country.
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