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These few pages explain the links between the following indicators: (1) Budget deficit and its impact on (a) trade deficit (b) current account deficit (c) interest rate (d) inflation rate (e) portfolio capital outflow and (f) exchange rate. (2) Subsidies and their impact on budget deficit. Subsidies consist of handouts to people in cash and kind; to industries in different forms and to agriculture in terms of lower price of fertilizer; higher tariffs on import of agricultural goods. (3) Higher subsidy requires the government to borrow more money from the market. Governments’ borrowing makes less money available for private sector investment. Competition between the two sectors raises interest rate. Higher interest rate payment and subsidy payment enlarges the budget deficit and produces adverse effect on GDP and other indicators such as trade deficit, current account deficit, capital outflow, exchange rate etc. Statistical Analysis: Theoretical Background Economic theory and the experience of the prolonged recession in the global economy suggest that most indicators of the economic health of a country and its GDP growth rate are greatly influenced by the state of the government’s budgetary balance and by the level of prudence exercised in its fiscal management. A surplus in the budget tends to improve the country’s trade and current account balances in its balance of payment account; to increase the inflows of FDI and portfolio capital; to strengthen the value of its currency against that of major currencies in the international market; to prevent the rise in interest rate (discount rate and commercial lending rates); and to facilitate the rise in the size of its GDP and in GDP growth rate. On the other hand, a deficit in the government’s budgetary balance fuelled by increase in payment of subsidies and rising interest payment on public sector loans tends to produce deleterious effects on most of such indicators as mentioned above of economic health of the country and to drive the portfolio capital out of the country. A deficit in a government’s budget tends to occur when the size of that government’s budgetary expenditure exceeds that of its budgetary revenue. This deficit is made up by a loan of an equivalent amount from the market or from the central bank. The competition between public sector and private sector entities in the loanable fund market drives up the rate of interest and produces a “crowding out” effect on private sector led investment which in turn produces an adverse effect on the country’s GDP growth rate. The rise in the rate of interest increases the cost of production of all kinds of goods and services which include those destined for the export market thereby lowering the country’s income from export. But the rise in inflation resulting from the rise in cost of production of goods and services in the home market makes unit prices of foreign goods cheaper in the home market. This in turn increases both quantity and total cost of imports which in turn tends to make the size of the payment for import higher than that of the income earned from exports. These deficits in trade and current account balances are therefore directly linked to the deficit incurred by the government in its budget. Furthermore an alarming rise in the share of this deficit in the country’s GDP lowers the global confidence in the country’s economic health. In the services account in the country’s current account balance, income outflow, now tends to exceed income inflow, thereby creating and or further enlarging the current account deficit. The loss of confidence of foreign investors in the economic strength of the country, makes the ”herd mentality” take hold in foreign investors’ sentiment thereby driving foreign capital out of the country and simultaneously depreciating the value of the domestic currency in the foreign exchange market. If this rate of depreciation of the currency becomes quite severe, it may fail to increase income from export well enough to pay for payments of imported goods. Meanwhile, the rise in the share of budget deficit and current account deficit in the country’s GDP well above 4 percent significantly increases the likelihood of global rating agencies according “Junk Status” to the country’s Sovereign Bonds. Once this happens, interest rate on Sovereign Bonds continues to rise and economic activities tend to rapidly decelerate. The rate of economic growth may become negative and the country turns itself into a “Pariah State“. Since subsidies are used to prop up inefficient agricultural sector and to some industrial units as well as to fund other unproductive welfare schemes by democratically elected governments to buy votes in election to stay in power, in order to reduce the size of the budget deficit, the income of the government from revenue collection has to rise and the level of expenditure has to fall. However since the rural sector and agriculture account for the overwhelming proportion of total subsidy payment in India in particular, subsidies by adversely affecting the budgetary balance, are also adversely affecting all other indicators of economic health of the country. In the quantitative analysis, therefore, we are required to examine (i) the corelation between subsidy and major indicators of economic health of the country such as budget deficit or surplus, movements in the discount rate, size of the GDP and economic growth rate; (ii) co-relation between budgetary balance and (a) balance in trade and current account; (b) movement of portfolio capital ; (c) exchange rate movement; (d) movement in discount rate; (e) size of the GDP growth in absolute amount and as percentages. =============================================== Dependences to choose: 1. A surplus in the budget tends to improve the country’s trade and current account balances in its balance of payment account. 2. A surplus in the budget tends to increase the inflows of FDI. 3. A surplus in the budget tends to increase the inflows of portfolio capital. 4. A surplus in the budget tends to strengthen the value of its currency against that of major currencies in the international market. 5. A surplus in the budget tends to prevent the rise in interest rate. 6. A surplus in the budget tends to prevent the rise in discount rate. 7. A surplus in the budget tends to prevent the rise in commercial lending rates. 8. A surplus in the budget tends to facilitate the rise in the size of its GDP. 9. A surplus in the budget tends to facilitate the rise in GDP growth rate. 10. A deficit in the government’s budgetary balance fuelled by increase in payment of subsidies and rising interest payment on public sector loans tends to produce deleterious effects on most of such indicators as mentioned above of economic health of the country and to drive the portfolio capital out of the country. A deficit in the government’s budgetary balance fuelled by increase in payment of subsidies and rising interest payment on public sector loans tends to produce deleterious effects on most of such indicators as mentioned above of economic health of the country and to drive the portfolio capital out of the country. 10a. 11.