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Understanding Crowding Out

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  • 1. Copyright © 2009 Understanding Crowding Out PSS SeriesThere is a term – CROWDING OUT which is liberally used in the pink business newspapers that cover the macro-economic issues. So what isCROWDING OUT all about? To understand this let us consider a story about a school where there several deserving students going about their dailyroutine. However, there is something very odd going on in the school.There is one student among them who is exceptionally strong. He tends to overpower the others most of the time due to his physical strength andpower and they are left defenseless. When he goes to the canteen, he eats much more than he should without considering the needs of his friends.The canteen authorities do not object because they know that he comes from a very influential family, and if they were to deny him extra food, theywould have to bear adverse consequences of doing so.Now because our friend – Mr. Strong and Powerful eats up most of the food, the prices of the items sold in the school canteen start to soar upwardsmaking it expensive for the other students.The other students though not as strong, are quite brilliant otherwise. But they too need to eat well to be able to perform to their full potential. Becausethe food becomes expensive, they are forced to compromise and thus results in their eating less. This also hurts their performance. As a result,because of one student who consumes a larger share of food than what he should, the others get deprived of the nutrition that is needed. Therefore, theother students are unable to exploit their potential to the best possible extent being deprived of vital nutrients.So in a sense we can say that the larger student has “elbowed out” the physically weaker classmates on the back of his power and strength and notbecause of capability.Now let us consider another story that is being played day in and day out in our country and which bears a lot of resemblance with the above story. Inorder to get a better understanding of this story we will have to make some changes (replacements) These are as follows :-1) We need to replace the stronger student by the Government2) We need to replace the other students by private entrepreneurs3) We need to replace food by capital And lo and behold, the scenario transforms to what is happening to the investment climate in our economy. Like Mr. Big and Strong, the government isconsuming a larger share of the available capital for investments. In a sense the government can do so because it is the government. Because of this,the cost of capital is going up just as the cost of food had gone up for the students.So just as the students felt deprived, the entrepreneurs too are feeling “CROWDED OUT” of the opportunity of making sound investment decisions.The higher cost of capital adversely impacts the feasibility of their ideas / projects and they are unable to contribute fittingly to the growth of theeconomy.Hope this lesson has helped you in understanding the term Crowding Out. For feedback / questions, email professor@tataamc.comDisclaimer: The views expressed in this lesson are for information purposes only and do not construe to be any investment, legal or taxation advice.The contents are topical in nature and held true at the time of creation of the lesson. This is not indicative of future market trends, nor is Tata AssetManagement Ltd. attempting to predict the same. Reprinting any part of this presentation will be at your own risk. Tata Asset Management Ltd. will notbe liable for the consequences of such action. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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