Fiscal deficit turns out to be inflationary in the government finances it by way of deficit financing. Deficit financing means that the government borrows from Reserve Bank of India. The government issues treasury bills against which the RBI gives cash to government and this increases money supply in the economy. Increase in money supply leads to increase in the general price level and a persistent increase in price level over a period of time. This increase culminates into an inflationary spiral, which is a wage price spiral. It means wages catching prices and prices catching wages in turn. It affects the process of growth of economy and raises the cost push inflation.

Therefore, the physical deficit should be carefully managed in an economy. If it is managed by increasing production it may not be inflationary.