📈 The Impact of India's Increased Borrowing
Here's how the government's increased borrowing will impact us and the economy.
Last week's Budget session had several standout announcements, like the crypto tax or the introduction of the digital rupee, or a focus on drones.
But one major announcement was that the government would be spending Rs. 7.5 lakh crores this year! That's a 34.5% increase from last year.
Wondering how this massive spending spree will impact us? ReadOn!
Why Does the Government Spend Money?
Government spending is crucial for any economy to grow.
After all, when the government funds projects like infrastructure development, hundreds and thousands of people get employment.
When these people get employed, their spending power increases, so they buy more goods and services.
This in turn helps the companies providing these goods and services, so they hire more people, who then spend more.
This virtuous cycle ensures that money is constantly being pumped into the economy and it keeps growing.
But this is a tricky business. It could also have some negative consequences. How?
Government Borrowing
Most countries, especially developing countries like ours, cannot bear the entire cost of expenditure themselves.
So, they borrow money from other countries and their own citizens through government securities and bonds.
To fund this year's massive spending spree, the government plans to borrow Rs. 11.6 lakh crores, which is Rs. 2 lakh crores higher than last year.
Sounds like we're falling into a debt trap?
That’s because maybe we are. Thanks to our increased borrowing throughout the years, this year Rs. 9.31 lakh crores or half of our tax revenue (Rs. 19.35 lakh crores) is set to go just to pay off our interest on debts. And with the RBI and other central banks set to raise interest rates to control inflation, the government may have to pay a much higher interest next year.
Now you see why we didn't get an income tax deduction?
Since the government will be borrowing more, the yields (returns) on bonds have shot up, as people are expecting more bonds to hit the market. Currently, the bond yield has reached a two-year high of 6.9%! This is also thanks to the Federal Reserve announcing that it will be increasing interest rates soon, which could potentially cause the stock market to tumble (Here's why).
But surely, that's good news ReadOn? Bond investors will be so excited!
Well, future bond investors are but not the current ones.
The rise in yields has caused debt funds to enter negative territory. This is because many existing investors sold their bonds plus the rise in yields wiped off a major portion of the market value of these funds. Huh?
You see, bonds pay a fixed interest rate. If it's 5% today, it will be 5% next year as well.
So, then how are yields rising? That's the magic.
When yields rise what basically happens is the price of the bond decreases.
Example: A 5% interest rate on the face value of Rs. 100 bond will always give you Rs. 5 as interest every year, regardless of its price. But say the price of the bond in the market becomes Rs. 90. You can effectively buy a Rs. 90 bond to get Rs. 5 interest, which is technically said to be a “yield” of Rs. 5 / Rs. 90 = 5.55%.
So, existing investors are at a loss. The bond that they had bought for let's say Rs. 100 is now worth Rs. 90.
Therefore, the market value of the funds that debt funds had held has declined.
Plus, the investors are also kind of at a loss. They could have gained the same interest for Rs. 90 but they have already paid more.
Not just that, if they now go to sell the bond, it will be priced below the value that they had purchased it for. So, they will have to hold on to the bond till maturity.
Okay, so there's no harm in that right?
That's the catch. You see, if these investors keep holding on to these bonds, a part of their income is tied up. So, they won't be investing or spending this income, preventing this money from entering the economy.
Plus, thanks to the high yields, more investors will invest their income in bonds.
So, the government's ultimate aim of increasing public spending has kind of fallen flat on its face, no?
But that's just one side of the coin.
This doesn't mean that more government spending will not actually boost the economy. It will still add lakhs of jobs and create better public infrastructure for us.
However, the government should be careful in balancing out its debts, borrowings and expenditure.
Otherwise, it could mean a big disaster for us in the future as the government will have to increase its earnings by taxing us more. An ever-increasing fiscal deficit could also cause a major economic crisis.
Do you think the increased government borrowing this year was a good idea?
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