HRBA, Deficit Spending and Financing Applying the HRBA framework to deficit spending and financing answers the following questions: o What are the limits to current policy on deficit spending and financing from a human rights perspective? . How can HRBA principles guide policy in the area of deficit spending and financing? o What are the elements of financing? a human rights based approach to deficit spending and Deficit Spending and Financing When the government spends more than its revenues, it engages in deficit spending, i.e., it borrows an amount equal to the deficit. lt may borrow from the private sector (domestic and foreign), other governments, and multilateral financial institutions. This borrowing adds to the stock of public debt. Deficits represent how much the government borrows in a particular year. The public debt is the accumulated borrowings on which interest is paid. ln principle, the government may borrow from the central bank which issues the country's own currency.'8 Borrowing from the central bank does not add to the public debt, the central bank being part of the public sector. lt also carries no interest: what the government pays to the central bank in interest comes back in the form of dividends. Central bank lending to the government does lead to an increase in reserve holdings of the banking system. Deficit financing refers to the way by which the government chooses to cover the gap between revenue and expenditures or the fiscal deficit. ln the standard view, either way of financing the deficit imposes high costs on the economy. On the one hand, a high public debt stock forces the government to raise taxes and devote an increasing proportion of revenues to interest payments. As the debt piles up, creditors demand a higher interest rate, which discourages productive investment-and raises the risk of debt distress. On the other hand, borrowing from the central bank generates inflation and leads to a devaluation of the local currency. The emphasis on borrowing risks has instilled a strong bias against deficit spending and the deployment of certain forms of financing the deficit. '8 Government borrowings from the central bank are normally in the domestic currency, pesos, which the latter issues. But the large accumulated foreign exchange reserves of the central bank make it a potential source of cheap foreign currency loans for the government. By borrowing from the central bank, the government saves on interest cost-a significant portion of which is the risk premium imposed by financial markets with or without reasonable basis-and professional fees charged by banks hired to arrange foreign loans. The government also avoids costly tied bilateral loans as well as onerous policy conditionalities imposed by multilateral lending agencies such as the WB, ADB and the lMF. lt is not surprising that private banks and official creditors oppose the use of foreign exchange reserves to lend to the government. 80