Crowding Out of Investment

Context:

Finance Minister Nirmala Sitharaman has pegged fiscal deficit for the coming year 2021-22 at 6.8% of GDP and aims to bring it back below the 4.5% mark by 2025-26.
This year’s fiscal deficit has been funded through government borrowings, multilateral borrowings, Small Saving Funds and short term borrowings.

Content:

Crowing Out of Investment

It is a situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending is called crowding out effect.
Sometimes, government adopts an expansionary fiscal policy stance and increases its spending to boost the economic activity. This leads to an increase in interest rates. Increased interest rates affect private investment decisions. A high magnitude of the crowding out effect may even lead to lesser income in the economy.
With higher interest rates, the cost for funds to be invested increases and affects their accessibility to debt financing mechanisms. This leads to lesser investment ultimately and crowds out the impact of the initial rise in the total investment spending. Usually the initial increase in government spending is funded using higher taxes or borrowing on part of the government.