Introduction
India government spending has been increasing over years. Currently the country is experiencing a budget deficit of 4.3% of gross domestic product. Sizeable amount of the deficit is financed by borrowing internally, however considerable amount is also borrowed externally. The high budget deficit is attributable to increased spending on direct cash subsidies and weak economic growth outlook which does not allow the government to increase tax. The subsidies which have lately been increased are petroleum and food subsidies. On the other hand, the weak economic performance has been attributed to decreasing external and internal demand of India’s goods and services something which has led to decline in amount collectable tax revenue. The government has made it clear that, the increased spending is aimed at increasing aggregate demand so as to improve the economic performance of the country. The government is therefore increasing aggregate demand by lowering taxes and increasing subsidies which reduce the cost of production with a aim of directing the economy out of recession to economic boom.
Government spending is made to influence economic growth and development in a country. Keynes advocated for government interference in the economy because market forces may not be adequate in maintaining the required low levels of unemployment and inflation. However, the intervention may be in favor of some sectors which may be more influential in controlling inflation as well as unemployment. Therefore, the government spends more money in some sectors than in others.
The Indian government has increased its spending on cash subsidies such as food and petroleum and left out subsidies at other sectors relatively at low levels. The logic behind increased expenditure on food is to make the basic need available and affordable to all citizens. This is because the subsidies will decrease cost of production hence increasing the number of investors in agricultural sectors. Making the food cheap is better than letting the prices stay high and unaffordable to many because the government will forced to purchase the food and offering it for free to the people (subsidies are cheaper than offering the food freely to people). On the other hand, increased subsidy on petroleum products is made to lower general cost of production and avoid cost push inflation. Across the country, petroleum product is a main energy cost of production therefore if this cost is lowered the entire manufacturing sector will feel a positive impact. According to Keynesian school of thought, the increased production increases the supply side of the economy and this leads to long run economic growth. The economic growth is brought about by multiplier effect of government spending. Whereby, the increased government spending leads to increase in household spending because of increased disposable income this increases firms’ revenue making them to increase expenditure in capital investments. Through the increased production the investors will need additional labor as well hence the unemployment level will fall hand in hand with inflation.
Despite these advantages, the increasing deficit makes the government to increase domestic and foreign borrowing and it is likely that the government’s cost of borrowing has been increasing i.e. interest rate on government bonds and securities so as to attract more buyers. This high cost of borrowing will lead to increased taxes in future. Apart from increased taxes in long run, the private sector investment expenditure may decrease because the government may borrow a lot of money from domestic financial institution leaving very little for private sector to borrow. In addition, the increased domestic borrowing by the government will lead to increased demand for credit and this will make financial institutions to increase interest rates (cost of credit) hence discouraging investors. Likewise, when interest rate on government bonds increase the private savers will find it more attractive to purchase the bonds than to save the money in private banks. This definitely decreases the supply of loan funds in private sector and this in turn leads to increased borrowing cost because demand for loans will be above supply of loan funds. The government should therefore limit its internal borrowing to avoid crowding out private investment because this may reduce net investment which will reduce overall income in the country.
The government has also increased its expenditure on state co operations in an attempt to increase available goods t affordable prices as well as create employment opportunities. This means that the government will be competing with private sector in provision of goods and services. This may be appositive move because supply of goods and services may increase and this forces private sector to increase the efficiency in production process and quality of their products so as to effectively compete with the government products. However, these co-operations are well known for operating inefficiently and may incur high losses which force the government to increase its deficit further in an attempt to bail them out. In addition, the increased government businesses may make it unattractive for private firms and generally foreign investors to start businesses which may compete with government co operations. This is because the cooperation’s sole aim is not to maximize profit but to provide the goods at affordable price for the citizens. Therefore, it may offer the output at a very low price making it impossible for private investors to provide the same commodity and make profit. The government should therefore monitor its investments not to go beyond a given threshold to avoid discouraging private investors because the net investment may fall if private firms stop expanding.
The Indian government has also decreased the amount of tax and this has been previously mentioned as a cause for the increased budget deficit. Tax on house hold reduces the amount of disposable income. Therefore, if tax on households is decreased the amount of income available for consumption increases and this leads to increase in demand for goods and services. In turn, firms will increase the rate of production so as to supply enough goods to meet the increased demand. This means that firms will increase their investments on capital goods and labor as they increase their production. However, this may not always hold water because the increased deposable income may be spend on imported products. This means that, the demand for locally produced goods may fall or remain at the same level. Therefore, to increase the aggregate demand of local commodities the government should look for ways of controlling the demand of foreign goods. For example, the government may increase import duty or even make it difficult to obtain import license so as to limit availability of foreign goods in local market.
The decrease in payable tax also acts as incentive to work. Therefore, many people may increase their working hours so as to increase their income. In this situation it is likely that there will be adequate supply of labor and labor cost may fall overtime. Decreased labor cost decreases the cost of production because labor is a main factor of production, this may attract foreign investors in India and encourage expansion of firms hence creating additional employment. However, this may have negative effects to the economy if effective labor laws are not passed in the country because the unemployment level is relatively high. Meaning that when those employed choose to work overtime then the unemployed will still lack jobs and this will not decrease the dependency ratio in the country. Therefore, to maximize benefits of increased labor demand laws which encourage employment of those unemployed should be passed to discourage supply of labor by working overtime.
Despite any negative effect which may arise, foreign investment in India is highly welcomed because it can stop the viscous cycle of poverty in the Indian villages. It is economically obvious that when new investment is made in a village will enable the local people to sell their outputs to the firms and offer labor and this enables them to earn income which can meet some of their basic needs. When people can meet their basic needs then the government decreases its transfer payments and it is able to direct its expenditure to investments. Therefore, additional investment will definitely increase employment opportunities, lower poverty level and relieve the government burden of providing basic needs to the citizens at either subsided cost or for free.
The government has decreased the amount of tax charged on interest obtained from saving. This move is made encourage the citizens to save more of their income than before and this ensures that there are adequate supply funds for banks to lend to private investors. It is generally acceptable that, savings need to be mobilized in order to invest so private investors will be able to obtain funds needed to invest. However, through the paradox of thrift, if everyone in the society saves a big proportion of his or her income in long run the amount of saving in the entire country falls. This is because saving reduces money available for spending and this decreases the aggregate demand making it irrelevant for private firms to increase production. However, this may be a myopic perspective because the Indian economy is open economy. Therefore, if investors get cheap loans from local financial institution they may expand their production and increase the exports because their goods produced may become more competitive in international market because of decreased cost of capital. Therefore, if the firms are able to get foreign market, it is probable the investment will keep on increasing and they will hire more people and this will decrease the level of unemployment.
The Indian government has also passed policies which influence the way business is to be conducted. For example, it has put forward labor policies which make it difficult for firms to recruit and layoff employees. These policies have decreased the mobility of labor in the country and this has been a stabling block to companies which need to change their production process. The strict labor policies have been discouraging foreign investors from establishing in India.
Conclusion
The Indian budget deficit has been increasing overtime. This has been attributed to the increased subsidies on petroleum and food products as well as decreasing tax rates and increasing expenditure on state owned cooperation. The deficit budget is an expansionary fiscal policy keen in increasing the aggregate demand in the economy which is expected to rekindle economic growth and create employment. It is expected that decreased tax increases the disposable income and this is key to increasing aggregate demand. Apart from decreasing income tax, the country has also decreased tax on savings so as to encourage people to save more in an attempt to increase supply of loan funds to domestic financial institutions. on the other hand, subsidies on petroleum products decreases the cost of production something which motivates the existing investors to expand and foreign companies to establish industries in India. The low cost of production resulting from the subsidies is meant to control cost push inflation. Moreover, the increased government investment on state cooperation is made to increase: employment opportunities, service delivery and increase completion which brings efficiency in production process.
However, the effect of this increasing deficit has got some negative implications. For example, the increased borrowing from domestic financial institutions decreases the amount of loan funds available for private investors. In addition, it makes cost of credit to increase and this as well discourages private investment. In a nut shell the increased internal borrowing is likely to crowds out the private investment in India, while the increased operations of state owned companies will discourage private and foreign investors from investing in sectors dominated by the government.
