Expenditure and Deficit Financing
The expenditure of the government can be classified into plan expenditure and non-plan expenditure.
Plan expenditure is an expenditure that the government plans to incur on a scheme to be implemented in a given year. For example, expenditure incurred for construction of national highways, mentioned in the budget, comes in as a part of plan expenditure.
Non-plan expenditure is the committed expenditure that includes Interest payments, pensions, salaries, subsidies and maintenance.
Expenditure on both plan and non-plan front can be categorized into capital and revenue expenditure.
Capital expenditure includes that expenditure which leads to creation of assets whereas revenue expenditure does not involve asset creation and is recurring in nature.
Examples: The construction of the national highways would involve expenditure on aggregate, bitumen or cement (depending upon the nature of the road) and certain machinery. This expenditure would be classified as capital expenditure. The labor charges would be classified as revenue expenditure.
Accordingly, the expenditure on maintenance would be non-plan and can be further categorized into non-plan capital expenditure and non-plan revenue expenditure.
The government fails to match its expenses with what it earns and thus has to resort to deficit financing. It makes good of this gap by borrowing in various ways. On this borrowing, the government has to pay a certain amount of interest. The interest payments as explained above are a part of non-plan expenditure.
Conventional wisdom tells us that money that is borrowed needs to be invested in areas where the return generated is greater than interest to be paid on the debt (i.e. the return generated should be greater than the cost of capital). But the government cannot always work with the profit motive in mind. The government is not earning enough to pay back the interest on its debt. So what is it doing? It is taking in more debt to repay its earlier debt and the interest that is to be paid on the existing debt. This seriously is an ill-indicator!