Crowding out

The idea that heavy government borrowing absorbs savings that would otherwise have funded private investment, raising interest rates for everyone.

Its force depends on whether the economy is at capacity. Where savings are idle and demand is weak, government borrowing can raise output rather than displacing private spending; where resources are fully employed, the displacement is real.

In India the effect is muted by the requirement that banks hold government securities, which creates captive demand, and sharpened by periods of heavy state borrowing alongside strong credit demand.

Watch the government bond yield when both are rising together.

Whether it bites depends on whether the economy is full.

The Indian version of the argument has an extra term, which is the captive demand created by the statutory holding requirement for banks. That requirement guarantees a buyer for a large volume of government paper regardless of price, which suppresses the yield the government pays and pushes the cost of the deficit onto bank profitability rather than onto the bond market. The displacement is real; it simply appears as a lower net interest margin across the banking system rather than as a higher visible yield.