Threshold level of fiscal deficit: revisiting FRBMA limit in Indian states
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Threshold level of fiscal deficit: revisiting FRBMA limit in Indian states Dinabandhu Sethi1 · V. V. Subba Rao1 · Asit Ranjan Mohanty2
© Institute for Social and Economic Change 2020
Abstract This paper examines whether the fiscal deficit limit of 3% as prescribed by the FRBMA is justified keeping in mind the increasing spending requirement and economic growth of Indian states? The study uses a panel data framework of taking sixteen non-special category states of India for the period over 2001–2002 to 2016–2017. This paper is the first of its kind that uses a threshold regression model due to Khan and Senhadji (IMF Staff Papers 48(1):1–21, 2001) to find the threshold level of fiscal deficit. The empirical findings show that the threshold level of fiscal deficit in sixteen states taken together is found to be 3%, which is in the line of prescribed limit of FRBM act. But at disaggregated level, it is observed that in middle- and low-income states the threshold level of fiscal deficit is 3.9% and 3.5%, respectively. This suggests that states can go for some additional percent of fiscal deficit above the limit prescribed by FRBMA. Therefore, the fiscal deficit limit of 3% needs to be revisited to give more fiscal room to the Indian states. Keywords Fiscal deficit · Threshold regression · FRBM rule · Economic growth JEL classification H72 · H62 · C23
Introduction With increasing decentralization, Indian states are entrusted with more responsibility to provide public goods and services, investment in physical and social infrastructure. To fulfill these objectives, they need more fiscal flexibility in the form of public expenditure. Financing infrastructure and developmental expenditure through fiscal deficit could
* Dinabandhu Sethi [email protected] V. V. Subba Rao [email protected] Asit Ranjan Mohanty [email protected] 1
CEFT, Xavier University, Bhubaneswar 751013, India
2
Xavier University, Bhubaneswar 751013, India
13
Vol.:(0123456789)
Journal of Social and Economic Development
stimulate private sector investment. However, this may lead to both rising interest payment and debt burden through accumulation of outstanding debt, and if left uncontrolled then it can cause macroeconomic instability. India faced an acute financial crisis in 1999, and average fiscal deficit of central government was over 6% of GDP during 1994–1999. At the end of FY 1999, Central government’s liabilities were about 50% of GDP. At the end of 1998–1999, total Central government liabilities at Rs. 875,625 crores outstripped its total assets at book value of Rs. 528,399 crores at the end of FY 1999. This gap was due to accumulation of debt to finance revenue account.1 High fiscal deficit, rising interest burden and huge debt burden triggered fiscal unsustainability and macroeconomic instability in India. In order to address this fiscal stress and macroeconomic shock, a set of fiscal rules were legislated in 2003 as Fiscal Responsibility and Budget Management (FRBMA) Act. The major objective of FRBMA is to bring in
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