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[Yojana Archive] Harnessing Multiplier Effect

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March 2022

Context

  • Recently, the Finance Minister has stressed upon the need to increase capital expenditure by both public sector as well as private sector.
  • This is in order to improve the economic growth and invigorate demand in the country.

Why increase CAPEX?

  • As per the various studies, capital expenditure has a multiplier effect of 2.45 in the short term and 4.8 in the long term.
  • This means that a single rupee spent on capital expenditure has the potential to add Rs 2.45 in the short term and Rs 4.8 in the long term to the overall economy.

What is multiplier effect in economy?

  • The multiplier effect is an economic term, referring to the proportional amount of increase, or decrease, in final income that results from an injection, or withdrawal, of capital.
  • In effect, it measures the impact that a change in economic activity—like investment or spending—will have on the total economic output of something.

Amount of Capital Expenditure in this year Budget

  • The budget for 2022-23 has proposed a hike of 24.47% in capital expenditure, amounting to almost Rs 7.5 Lakh Crore.
  • If grants in aid for the creation of capital assets (including MGNREGA assets) are included in the capital expenditure, the effective capital expenditure increases to Rs 10.68 Lakh Crore.
  • This is 27% more than the capital expenditure of Rs 8.4 Lakh Crore in 2021-22.

Similar Provisions in the Budget

  • Due to COVID-induced economic slowdown, the Union government has relaxed various provisions related to expenditure.
  • For e.g. the Borrowing limit for the states has been enhanced to 4% of the Gross State Domestic Product (GSDP). 
  • The government has allowed Rs 2 Lakh Crore for States and Autonomous bodies for capital expenditure.

Need for Increase in Capital Expenditure

  • Pandemic: As mentioned above, COVID-induced lockdown has resulted in closure of industries for an extended period of time.
  • Crowding-in private investment: There is a need to crowd-in private investment through direct investment and signalling through favorable policy interventions by the government in the Economy.
  • Shortfall in Tax Revenues: The pandemic has led to a decrease in the realization of tax revenues due to a fall in demand as well as temporary closure of industries. This can be countered by sustained investment by the government, providing the necessary boost to animal spirits within the Economy.
  • Benefits of Capital Expenditure: Capital Expenditure has various effects on the Economy of a country including creating capacity and increasing supply, increasing employment generation and rise in wages, in turn, stimulating demand for the goods and services and attracting FDI.
  • Supplementary fundings: The increased allocations would be available for investment in PM Gati Shakti Plan and its associated initiatives. The funds can also be used for supplementary funding in projects like PM Gram Sadak Yojana.
  • Scheme for Special Assistance to States for Capital Expenditure: These funds under will also be used to encourage the government to undertake reforms for increasing the development in the States. The associated sectors include digitization of the Economy, including digital payments, and reform in areas like town planning, transit oriented development, building bylaws and transferable development rights.

Conclusion

  • Overall, this budget aims to create a long-term multiplier effect by focusing its resources and capital in the right direction.
  • In future years, the government will need to stay the course set today, as the impact of these initiatives will be seen in the long term.
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