Fiscal Deficit and Economic Growth Nexus in India: A Simultaneous Error Correction Approach
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Fiscal Deficit and Economic Growth Nexus in India: A Simultaneous Error Correction Approach Ranjan Kumar Mohanty1
© The Indian Econometric Society 2020
Abstract This paper examines the impact of fiscal deficit on economic growth in India, during the period from 1970–71 to 2018–19. Using a combination of Autoregressive Distributed Lag and Simultaneous Error Correction Approach, this study shows that fiscal deficit and revenue deficit have an adverse effect on economic growth both in the long run and in the short run. The empirical analysis confirms that fiscal deficit influences economic growth both directly, and indirectly through the routes of investment, interest rate, current account deficit and composition of government expenditure. Further, gross investment has a positive and inflation rate has a negative impact on economic growth. For a policy perspective, the government should control fiscal deficit and revenue deficit as suggested by the FRBM Act. The composition of government expenditure should be altered to devote more resources for the formation of productive capital in India. Keywords Fiscal deficit · Revenue deficit · Economic growth · Autoregressive distributed lag (ARDL) model · Simultaneous error correction approach JEL Codes C32 · H62 · O40
Introduction The effects of fiscal deficit on economic growth remain a highly debated issue in macroeconomics. India has experienced a persistence of high fiscal deficit during the last five decades.1 The capital expenditure as a percentage of GDP and the 1 The fiscal deficit of the central government has increased from 3.01% of the gross domestic product (GDP) in 1970-71 to more than 8% of GDP in 1986-87. Then, it has gradually declined to 4.4% in 200304 (FRBM Act, 2003 introduced in India), and it was more than 3% in 2018-19. It is to be noted that fiscal deficit has always been above the target set by FRBM Act (exceptional year 2007-08). Revenue deficit has increased from 4.5% of fiscal deficit in 1981-82 to nearly 65% in 2018-19. It implies that the
* Ranjan Kumar Mohanty [email protected]; [email protected] 1
Xavier Institute of Management, Xavier University Bhubaneswar, Bhubaneswar 751013, India
13
Vol.:(0123456789)
Journal of Quantitative Economics
developmental expenditure as a percentage of total expenditure have also fallen during this period. Unproductive expenditures such as interest payments and subsidies as a percentage of GDP have also increased. Thus, a significant proportion of the resources generated through fiscal deficit are used for seemingly unproductive expenditure. Such a scenario throws up several questions: Does the persistence of fiscal deficit hamper economic growth in India? Does it significantly affect economic growth in the long run and the short run? Does any indirect linkage exist between fiscal deficit and economic growth in India? Does the composition of government expenditure matter for economic growth in India? The empirical literature on the relationship between fiscal deficit and econo
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