Does Fiscal Deficit Matter for Economic Growth Performance of Indian States?
An Empirical Analysis
Considering a standard economic growth model, this study tries to empirically evaluate the effects of fiscal deficits on the economic growth of 14 major Indian states from 1980-81 to 2019-20. The panel fixed effect regression establishes that gross fiscal deficit (GFD), tax revenue, and inflation rates have a significant adverse impact on economic growth. In contrast, private investment, gross enrolment ratio (GER) in primary education, and the adoption of Fiscal Responsibility Legislations (FRLs) have favourable effects; non-tax revenues, GER in secondary education, and economic policy reform (EPR) didn't show any significant effect. Where FRLs were enacted, fiscal deficits showed a positive impact on growth in the post-FRL period. Further, we find a threshold effect of fiscal deficit on growth, implying that when GFD lies within a specified threshold, it has a positive impact; beyond this limit, it impedes states’ economic growth.
Keywords:Fiscal Rule, Fiscal Deficit, Tax revenues, Non-Tax Revenues, Economic Growth, Indian States
Arora, H. K., & Dua, P. (1993).Budget deficits, domestic investment, and trade deficits.Contemporary Economic Policy, 11(1), 29-44.
Amrutha, T., Gowda, H. C., Bi, A. Z., &Rashmi, K. S. (2017). Impact of fiscal deficit on economic growth in India: a cointegration analysis. International Research Journal of Agricultural Economics and Statistics, 8(1), 96-99.
Aschauer, D. A. (1985). Fiscal policy and aggregate demand. The American Economic Review, 75(1), 117-127.
Aschauer, D. A. (1989). Is public expenditure productive?. Journal of monetary economics, 23(2), 177-200.
Auerbach, A. J., Gale, W. G., &Orszag, P. R. (2002).The Budget Outlook and Options for Fiscal Policy.Available at SSRN 308562.
Avila, J. C. (2011). Fiscal deficit, macro-uncertainty, and growth in Argentina.
Baltagi, B. (2008). Econometric analysis of panel data. John Wiley & Sons.
Barro, R. J. (1974). Are government bonds net wealth? .Journal of political economy, 82(6), 1095-1117.
Barro, R. J. (1978). Comment from an unreconstructed Ricardian. Journal of Monetary Economics, 4(3), 569-581.
Barro, R. J. (1989). The Ricardian approach to budget deficits. Journal of Economic perspectives, 3(2), 37-54.
Barro, R. J. (1991). Economic growth in a cross section of countries.The quarterly journal of economics, 106(2), 407-443.
Barro, R. J. (1995).Inflation and economic growth.NBER Working Paper 5326. Cambridge, MA.
Barro, R. J., & Lee, J. W. (1994, June). Sources of economic growth.In Carnegie-Rochester conference series on public policy (Vol. 40, pp. 1-46).North-Holland.
Barro, R. J., &Sala-i-Martin, X. (1992).Convergence. Journal of political Economy, 100(2), 223-251.
Bhoir, R. B., &Dayre, S. R. (2015). Does India's economic growth independent of fiscal deficit?. The Business & Management Review, 5(4), 189.
Blejer, M. I., & Khan, M. S. (1984). Government policy and private investment in developing countries. Staff Papers, 31(2), 379-403.
Blinder, A. S., & Solow, R. M. (1974). Analytical foundations of fiscal policy.
Buiter, W. H. (1985). A guide to public sector debt and deficits. Economic policy, 1(1), 13-61.
Chakraborty, L. S. (2007). Fiscal deficit, capital formation, and crowding out in India: evidence from an asymmetric VAR model (No. 518). Working Paper.
Chakraborty P, Chakraborty L (2006) Is fiscal policy contracyclical in India: an empirical analysis. University Library of Munich, Germany, MPRA Paper
Chakraborty, P. (2017). Federalism, fiscal space, and public investment spending: do fiscal rules impose hard-budget constraints?. In Central and Local Government Relations in Asia. Edward Elgar Publishing.
Easterly, W., & Rebelo, S. (1993). Fiscal policy and economic growth. Journal of monetary economics, 32(3), 417-458.
Easterly, W., Rebelo, S., & Mundial, B. (1992).Marginal income tax rates and economic growth in developing countries. Country Economics Department, World Bank.
Edame, G. E., &Okoi, O. B. (2015). Fiscal deficits and economic growth in Nigeria: A chow test approach. International journal of economics and financial issues, 5(3), 748-752.
Eisner, R. (1989). Budget deficits: rhetoric and reality. Journal of economic perspectives, 3(2), 73-93.
Eisner, R., & Pieper, P. J. (1990). The world's greatest debtor nation? North American Review of Economics and Finance, 1(1), 9-32.
Evans, P. (1993). Consumers are not Ricardian: evidence from nineteen countries. Economic Inquiry, 31(4), 534-548.
Fatima, G., Ahmed, A., &Rehman, W. (2011). Fiscal deficit and economic growth: an analysis of Pakistan's economy.
Ghali, K. H. (1997). Government spending and economic growth in Saudi Arabia. Journal of Economic Development, 22(2), 165-172.
Green, W. H. (2003). Econometrics analysis (5e).Upper Saddle River, HNJ: Prentice Hall, 283-334.
Hausman, J. A. (1978). Specification tests in econometrics. Econometrica: Journal of the econometric society, 1251-1271.
Hsiao, C. (2014). Analysis of panel data (No. 54). Cambridge university press.
Hussain, M. E., & Haque, M. (2017). Fiscal deficit and its impact on economic growth: Evidence from Bangladesh. Economies, 5(4), 37.
Iqbal, N., ud Din, M., & Ghani, E. (2017). the fiscal deficit and economic growth in Pakistan: new evidence. The Lahore journal of economics, 22, 53-72.
Karras, G. (1994). Macroeconomic effects of budget deficits: further international evidence. Journal of International Money and Finance, 13(2), 190-210.
Lee, Y., & Gordon, R. H. (2005).Tax structure and economic growth.Journal of public economics, 89(5-6), 1027-1043.
Mankiw, N. G., Romer, D., & Weil, D. N. (1992).A contribution to the empirics of economic growth.The quarterly journal of economics, 107(2), 407-437.
Martin, R., &Fardmanesh, M. (1990). Fiscal variables and growth: A cross-sectional analysis. Public Choice, 64(3), 239-251.
Mendoza, E. G., Razin, A., & Tesar, L. L. (1994). Effective tax rates in macroeconomics: Cross-country estimates of tax rates on factor incomes and consumption. Journal of Monetary Economics, 34(3), 297-323.
Misra, B. M., & Khundrakpam, J. K. (2009). Fiscal consolidation by central and state governments: The Medium Term Outlook. RBI Staff Studies, May.
Mohanty, R. K. (2012). Fiscal deficit-economic growth nexus in India: A cointegration analysis. New Delhi: Centre for Economic Studies & Planning, School of Social Sciences Jawaharlal Nehru University.
Navaratnam, R., &Mayandy, K. (2016). Causal nexus between fiscal deficit and economic growth: Empirical evidence from South Asia. International Journal for Innovation Education and Research, 4(8), 1-19
Nayab, H. (2015). The relationship between budget deficit and economic growth of Pakistan.Journal of Economics and Sustainable Development, 6(11), 85-90.
Nelson, M. A., & Singh, R. D. (1994). The deficit-growth connection: Some recent evidence from developing countries. Economic Development and Cultural Change, 43(1), 167-191.
Odhiambo, O.S, Momanyi, G., Lucas, O. &Aila,F.O. (2013). The Relationship betweenFiscal Deficit and Economic Growth inKenya: An Empirical Investigation. Greener Journal of Social Sciences, 3(6): 306-323.
Olatunji, T. M., & Sunday, A. A. (2012). Econometrics Analysis of the Impact of Fiscal Stance on Economic Growth in Nigeria (1970-2010). ProsidingPerkem, 488-508.
Onwioduokit, E. A., & Bassey, G. E. (2013). Fiscal deficit and economic growth in the Gambia. International Journal of Current Research and Review, 5(22), 6.
Rahman, N. H. A. (2012). The relationship between budget deficit and economic growth from Malaysia's perspective: An ARDL approach. In International Conference on Economics, Business Innovation (Vol. 38, pp. 54-58).
Rana, E. A., & Wahid, A. N. (2017). Fiscal Deficit and Economic Growth in Bangladesh: A Time-Series Analysis. The American Economist, 62(1), 31-42.
Rangarajan, C., & Srivastava, D. K. (2005). Fiscal deficits and government debt: implications for growth and stabilisation. Economic and Political Weekly, 2919-2934.
Rangarajan, C., & Subbarao, D. (2007). The importance of being earnest about fiscal responsibility. Madras School of Economics.
Rao, M. G., & Chakraborty, P. (2006). Multilateral adjustment lending to states in India: Hastening fiscal correction or softening the budget constraint?. Journal of International Trade & Economic Development, 15(3), 335-357.
Reserve Bank of India (2010): Handbook of Statistics on State Government Finances, Mumbai
Seater, J. J. (1982). Are future taxes discounted?. Journal of Money, Credit and Banking, 14(3), 376-389.
Shen W, Yang SCS, Zanna LF (2018) Government spending effects in low-income countries. J Dev Econ 133:201–219
Skinner, J., & Mundial, B. (1988).Taxation and output growth in Africa.blinderEconomics Department, World Bank.
Taylor, L., Proano, C. R., de Carvalho, L., & Barbosa, N. (2012).Fiscal deficits, economic growth and government debt in the USA.Cambridge Journal of Economics, 36(1), 189-204.
Velnampy, T &Achchuthan, S. (2013). Fiscal Deficit and Economic Growth: A Study on Sri Lankan Economic Perspective, In Developing Country Studies, 3(3), 166-174.
Voss, M. (2002) "Public and Private Investment in the United States and Canada", Economic Modelling, 19(4): 641-664.