Publications
Lekha S. Chakraborty
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Working Paper No. 1056 | October 2024
Federal Tax Transfers and Demographic Transition: Balancing Equity and Efficiency
View More View LessAgainst the backdrop of demographic transition in India, the study highlights the necessity of integrating the elderly population as a critical factor in formula-based intergovernmental fiscal transfers. The demographic transition, characterized by an increasing elderly population, imposes unique fiscal challenges on states, necessitating a revision of transfer formulas to ensure equitable and efficient resource distribution. The paper employs a historical analysis of fiscal devolution criteria, and analyzes the impact of incorporating the elderly population into the devolution formula on the share of states in the total tax transfer to states. The findings indicate that integrating the elderly population into the tax devolution formula can significantly alter the distribution of resources among states, with states benefiting more while having a relatively larger elderly population. The study recommends considering demographic changes by incorporating the elderly to working age population ratio as a criterion used by the Sixteenth Finance Commission to promote a more equitable and efficient allocation of resources.
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Working Paper No. 1054 | June 2024
Gender-Responsive Public Financial Management: The Indian Chronology of Gender Budgeting
View More View LessGender budgeting is a public financial management (PFM) tool, used to ensure accountability mechanisms. The analysis of “process” indicators of gender-responsive PFM (GRPFM) reveals that India has been successful in integrating a gender lens within the budget cycle, including in the financial planning and allocation, and in effective implementation. However, a legally mandated GRPFM would be crucial for the sustained impact of gender budgeting on gender equality outcomes. The empirical analysis of the link between GRPFM and gender equality outcomes showed that flexibility of finances is crucial for a government to implement GRPFM. The unconditional fiscal transfers have relatively more impact on gender equality outcomes than conditional transfers. The plausible mechanism through which unconditional tax transfers impact gender equality outcomes lies in the flexibility of use of tax transfers by the subnational governments in prioritizing their gender-related commitments. This inference has policy implications for the 16th Finance Commission.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 1047 | April 2024
Analyzing the Tax Buoyancy of the Extractive Sector
Against the backdrop of fiscal transition concomitant to energy transition policies with climate change commitments, revenue from the extractive sector needs a recalibration in the subnational fiscal space. Extractive tax is the payment due to the government in exchange for the right to extract the mineral substance. Extractive tax has been fixed and paid in multiple tax regimes, sometimes on the measures of ad valorem (value-based) or profits or as the unit of the mineral extracted. Using the ARDL methodology, this paper analyzes the buoyancy of extractive revenue across the states in India, for the period 1991–92 to 2022–23 and analyzes the short- and long-run coefficients and their speed of adjustment. There are no identified structural breaks in the series predominantly because of the homogenous extractive policy regime shift to ad valorem from a unit-based regime. Our findings revealed that extractive tax is a buoyant source of own revenue, though there are distinct state-specific differentials. The policy implication of our study is crucial for a “just transition” related to climate change commitments where extractive industries’ tax buoyancy is compared to other tax buoyancy across Indian states, and can be used as the base scenario to estimate the loss of revenue when fiscal transition sets in with “just transition” policies. -
Working Paper No. 1040 | February 2024
COP28 and Environmental Federalism: Empirical Evidence from an Emerging Economy, India
View More View LessAgainst the backdrop of COP28, this paper investigates the impact of intergovernmental fiscal transfers (IGFT) on climate change commitments in India. Within the analytical framework of environmental federalism, we tested the evidence for the Environmental Kuznets Curve (EKC) using a panel model covering 27 Indian states from 2003 to 2020. The results suggest a positive and significant relationship between IGFT and the net forest cover (NFC) across Indian states. The analysis also suggests an inverse-U relationship between Gross State Domestic Product (GSDP) and the environmental quality, indicating a potential EKC for India. The findings substantiate the fiscal policy impacts for climate change commitments within the fiscal federal frameworks of India, and the significance of IGFT in increasing the forest cover in India. This has policy implications for the Sixteenth Finance Commission of India in integrating a climate change–related criterion in the tax-transfer formula in a sustainable manner.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 1032 | October 2023The policy evaluation is a crucial component in analyzing the efficacy of public spending in translating the money spent into desired outcomes. Using OECD evaluation criteria, we analyzed the child protection schemes of Odisha to understand whether legal commitments on child protection are translated into fiscal commitments. The intergovernmental fiscal transfers and state-targeted programs for children in need of care and protection (CNCP) and children in conflict of law (CCL) are evaluated using the OECD criteria of relevance, coherence, effectiveness, efficiency, and sustainability. Using the theory of change, various fiscal interventions for child protection are analyzed with activities, outputs, intended outcomes, and impacts. The analysis revealed that, in the post-pandemic fiscal strategy of Odisha, various programs have been designed by the government to tackle the capability deprivation, hardships, and vulnerabilities faced by children within the budgetary frameworks, and that these programs are made fiscally sustainable through public expenditure convergence within the classification of budgetary transactions. However, the low utilization ratios of the funds and the institutional constraints are identified as challenges in the effective implementation of child protection programs in Odisha.Download:Associated Program:Author(s):Related Topic(s):
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Working Paper No. 1023 | July 2023
Evidence From an Emerging Country, India
According to the theory of efficient markets, economic agents use all available information to form rational expectations. The rational expectations hypothesis asserts that information is scarce, the economic system generally does not waste information, and that expectations depend specifically on the structure of the entire system. Fiscal marksmanship—the accuracy of budgetary forecasting—can be one important piece of such information that rational agents must consider in forming expectations. Against the backdrop of fiscal rules, our paper explores the budgetary forecast errors of climate change–related public spending in India. The fiscal rules stipulate that fiscal deficit–to–GDP ratio should be maintained at 3 percent. However, in the post-COVID fiscal strategy, a medium-term fiscal consolidation path of 4.5 percent fiscal deficit–to–GDP is envisioned by 2025–26. Within this fiscal consolidation framework, we analyzed the budget credibility of fiscal commitments for climate change in India. We analyzed the fiscal behavioral variables in terms of bias, variation, and randomness, and captured the systemic variations in budgetary forecast related to climate change for a period 2017–18 to 2020–21 across sectors. We identified the sectors where systematic components of forecasting errors are relatively higher than random components, where minimizing errors through altering the fiscal behavioral models is done by revising the assumptions and by applying better forecasting methods. A state-level decomposition of the public spending revealed that disaggregated fiscal space available for developmental spending constitutes around 60 percent of the total. However, identifying the specifically targeted public spending related to climate change across all states and analyzing its fiscal markmanship can further the subnational inferences.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 1009 | August 2022
Empirical Evidence from Subnational Governments in India
Public financial management (PFM) has a significant role in linking resources to results by financing human development outcomes. When economic stimulus packages are short run in nature, thematic PFM, such as child budgeting, has a crucial role in reducing crime against children. Using fixed effects models, we explore the determinants of reduced crime against children. The PFM-related variables are found to have greater impact than economic growth per se in tackling crime against children. Capital expenditure in the social sector is found to be inversely related to crimes against children, though mere allocation in social sector budgets is not found to be effective in reducing crime rates. Specific PFM tools, like child budgeting, need to be analyzed for their role in child protection services. In India, child budgeting has been introduced in states where the rates of crime against children are also high. To understand the efficacy of child budgeting in reducing crime rates, the year of inception (year in which the child budgeting was introduced in the state) of children budgeting in a state is incorporated in the panel models. The coefficients reveal that years of inception and crime against children are inversely related, reinforcing the effectiveness of PFM tools such as child budgeting in reducing crimes. The existence of a positive link between social expenditure and the incidence of crime is at first counterintuitive, but a closer examination reveals a nonlinear relationship between crime incidence and social spending, which is revealed from the statistically significant negative squared term. -
Working Paper No. 1002 | February 2022
Empirical Evidence from India
Against the backdrop of the COVID-19 pandemic, this paper analyzes the economic stimulus packages announced by the Indian national government and tries to identify some plausible fiscal and monetary policy coordination. The shrinking fiscal space due to revenue uncertainties has led to a theoretical plausibility of a reemergence of finite monetization of deficits in India. However, the empirical evidence confirms no direct monetization of the deficit. -
Working Paper No. 990 | July 2021
Analyzing the Flypaper Effects
Using panel data models, we analyze the flypaper effects—whether intergovernmental fiscal transfers or states’ own income determine expenditure commitments—on ecological fiscal spending in India. The econometric results show that the unconditional fiscal transfers, rather than the states’ own income, determine ecological expenditure in the forestry sector at subnational levels in India. The results hold when the models are controlled for ecological outcomes and demographic variables.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 964 | July 2020
Analyzing the Fiscal Forecasting Errors of 28 States in India
Budget credibility, or the ability of governments to accurately forecast macro-fiscal variables, is crucial for effective public finance management. Fiscal marksmanship analysis captures the extent of errors in the budgetary forecasting. The fiscal rules can determine fiscal marksmanship, as effective fiscal consolidation procedures affect the fiscal behavior of the states in conducting the budgetary forecasts. Against this backdrop, applying Theil’s technique, we analyze the fiscal forecasting errors for 28 states (except Telangana) in India for the period 2011–16. There is a heterogeneity in the magnitude of errors across subnational governments in India. The forecast errors in revenue receipts have been greater than revenue expenditure. Within revenue receipts, the errors are more significantly pronounced in the grants component. Within expenditure budgets, the errors in capital spending are found to be greater than revenue spending in all the states. Partitioning the sources of errors, we identified that the errors were more broadly random than due to systematic bias, except for a few crucial macro-fiscal variables where improving the forecasting techniques can provide better estimates.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 937 | October 2019
Some Reflections
There is a growing recognition that fundamental changes are happening in Indian fiscal federalism ex post the abolition of the Planning Commission, the creation of the National Institution for Transforming India (NITI) Aayog, the constitutional amendment to introduce the Goods and Services Tax (GST), the establishment of the GST Council, and the historically high tax devolution to the states based on the 14th Finance Commission’s recommendations. Recently, policymakers and experts have raised a few issues, including: whether or not to make Finance Commissions “permanent” or to abolish them by making the tax devolution share constant through a constitutional amendment; the need for an institution to redress spatial inequalities in order to fill the vacuum created by abolishing the Planning Commission; and making the case for Article 282 of the constitution to be circumscribed. The debates are also focused on whether there is a need to establish a link between the GST Council and Finance Commissions, and if India should devise a mechanism of transfer that is predominantly based on sharing of grants for equalization of services rather than tax sharing. Creating a plausible framework for debt-deficit dynamics while keeping the fiscal autonomy of states intact and ensuring output gap reduction and public investment at the subnational level without creating disequilibrium were also other matters of concern. These debates are significant, especially when a group of states came together for the first time ever to question the terms of reference of the 15th Finance Commission amid growing tensions in federal-state relations in India.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 920 | January 2019
Efficacy of Gender Budgeting in Asia Pacific
Gender budgeting is a fiscal approach that seeks to use a country’s national and/or local budget(s) to reduce inequality and promote economic growth and equitable development. While the literature has explored the connection between reducing gender inequality and achieving growth and equitable development, more empirical analysis is needed on whether gender budgeting reduces gender inequality. Our study follows the methodology of Stotsky and Zaman (2016) to investigate the impact of gender budgeting on promoting gender equality across Asia Pacific countries. The study classifies Asia Pacific countries as gender budgeting or non-gender budgeting according to whether they have formalized gender budgeting initiatives in laws and/or budget call circulars. To measure the effect of gender budgeting on reducing inequality, we measure the correlation between gender budgeting and the Gender Development Index (GDI) and the Gender Inequality Index (GII) scores in each country. The data for our gender inequality variables are mainly drawn from the IMF database on gender indicators and the World Development Indicators database over the 1990–2013 period. Our results show that gender budgeting has a significant effect on increasing the GDI and a small but significant potential to reduce the GII, strengthening the rationale for employing gender budgeting to promote inclusive development. However, our empirical results show no prioritization of gender budgeting in the fiscal space of health and education sectors in the region.Download:Associated Program:Author(s):Related Topic(s): -
Working Paper No. 898 | October 2017The paper attempts to measure the incidence of corporate income tax in India under a general equilibrium setting. Using seemingly uncorrelated regression coefficients and dynamic panel estimates, we tried to analyze both the relative burden of corporate tax borne by capital and labor and the efficiency effects of corporate income tax. The data for the study is compiled from corporate firms listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange of India (NSE) for the period 2000–15. Our empirical estimates suggest that in India capital bears more of the burden of corporate taxes than labor. Though it is contrary to the Harberger (1962) hypothesis that the burden of corporate tax is shifted to labor rather than capital, it confirms the existing empirical results in the context of India.
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Working Paper No. 883 | February 2017
An Empirical Analysis of G20 Countries
This paper analyzes the effectiveness of public expenditures on economic growth within the analytical framework of comprehensive Neo-Schumpeterian economics. Using a fixed-effects model for G20 countries, the paper investigates the links between the specific categories of public expenditures and economic growth, captured in human capital formation, defense, infrastructure development, and technological innovation. The results reveal that the impact of innovation-related spending on economic growth is much higher than that of the other macro variables. Data for the study was drawn from the International Monetary Fund’s Government Finance Statistics database, infrastructure reports for the G20 countries, and the World Development Indicators issued by the World Bank.
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Working Paper No. 874 | September 2016
Is There a Case for Gender-sensitive Horizontal Fiscal Equalization?
This paper seeks to evaluate whether a gender-sensitive formula for the inter se devolution of union taxes to the states makes the process more progressive. We have used the state-specific child sex ratio (the number of females per thousand males in the age group 0–6 years) as one of the criteria for the tax devolution. The composite devolution formula as constructed provides maximum rewards to the state with the most favorable child-sex ratio, and the rewards progressively decline along with the declining sex ratio. In this formulation, the state with the most unfavorable child-sex ratio is penalized the most in terms of its share in the horizontal devolution. It is observed that the inclusion of gender criteria makes the intergovernmental fiscal transfers formula more equitable across states. This is not surprising given the monotonic decline in the sex ratio in some of the most high-income states in India.
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Working Paper No. 859 | February 2016
A Technical Articulation for Asia-Pacific
Against the backdrop of the 2030 UN Agenda for Sustainable Development, this paper analyzes the measurement issues in gender-based indices constructed by the United Nations Development Programme (UNDP) and suggests alternatives for choice of variables, functional form, and weights. While the UNDP Gender Inequality Index (GII) conceptually reflects the loss in achievement due to inequality between men and women in three dimensions—health, empowerment, and labor force participation—we argue that the assumptions and the choice of variables to capture these dimensions remain inadequate and erroneous, resulting in only the partial capture of gender inequalities. Since the dimensions used for the GII are different from those in the UNDP’s Human Development Index (HDI), we cannot say that a higher value in the GII represents a loss in the HDI due to gender inequalities. The technical obscurity remains how to interpret GII by combining women-specific indicators with indicators that are disaggregated for both men and women. The GII is a partial construct, as it does not capture many significant dimensions of gender inequality. Though this requires a data revolution, we tried to reconstruct the GII in the context of Asia-Pacific using three scenarios: (1) improving the set of variables incorporating unpaid care work, pay gaps, intrahousehold decision making, exposure to knowledge networks, and feminization of governance at local levels; (2) constructing a decomposed index to specify the direction of gender gaps; and (3) compiling an alternative index using Principal Components Index for assigning weights. The choice of countries under the three scenarios is constrained by data paucity. The results reveal that the UNDP GII overestimates the gap between the two genders, and that using women-specific indicators leads to a fallacious estimation of gender inequality. The estimates are illustrative. The implication of the results broadly suggests a return to the UNDP Gender Development Index for capturing gender development, with an improvised set of choices and variables.
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Working Paper No. 811 | July 2014
An Evaluation Using the Maximum Entropy Bootstrap Method
This paper challenges two clichés that have dominated the macroeconometric debates in India. One relates to the neoclassical view that deficits are detrimental to growth, as they increase the rate of interest, and in turn displace the interest-rate-sensitive components of private investment. The second relates to the assumption of “stationarity”—which has dominated the statistical inference in time-series econometrics for a long time—as well as the emphasis on unit root–type testing, which involves detrending, or differencing, of the series to achieve stationarity in time-series econometric models. The paper examines the determinants of rates of interest in India for the periods 1980–81 and 2011–12, using the maximum entropy bootstrap (Meboot) methodology proposed in Vinod 1985 and 2004 (and developed extensively in Vinod 2006, Vinod and Lopez-de-Lacalle 2009, and Vinod 2010 and 2013). The practical appeal of Meboot is that it does not necessitate all pretests, such as structural change and unit root–type testing, which involve detrending the series to achieve stationarity, which in turn is problematic for evolutionary short time series. It also solves problems related to situations where stationarity assumptions are difficult to verify—for instance, in mixtures of I(0) and nonstationary I(d) series, where the order of integration can be different for different series.
What makes Meboot compelling for Indian data on interest rates? Prior to interest rate deregulation in 1992, studies to analyze the determinants of interest rates were rare in India. Analytical and econometric limitations to dealing with the nonvarying administered rates for a meaningful time-series analysis have been the oft-cited reason. Using high-frequency data, the existing attempts have focused on the recent financially deregulated interest rate regime to establish possible links between interest rates and macroeconomic variables (Chakraborty 2002 and 2012, Dua and Pandit 2002, and Goyal 2004). The results from the Meboot analysis revealed that, contrary to popular belief, the fiscal deficit is not significant for interest rate determination in India. This is in alignment with the existing empirical findings, where it was established that the interest rate is affected by changes in the reserve currency, expected inflation, and volatility in capital flows, but not by the fiscal deficit. This result has significant policy implications for interest rate determination in India, especially since the central bank has cited the high fiscal deficit as one of the prime constraints for flexibility in fixing the rates.
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Working Paper No. 797 | April 2014
Evidence from India on “Processes”
Gender-responsive budgeting (GRB) is a fiscal innovation. Innovation, for the purposes of this paper, is defined as a way of transforming a new concept into tangible processes, resources, and institutional mechanisms in which a benefit meets identified problems. GRB is a fiscal innovation in that it translates gender commitments into fiscal commitments by applying a “gender lens” to the identified processes, resources, and institutional mechanisms, and arrives at a desirable benefit incidence. The theoretical treatment of gender budgeting as a fiscal innovation is not incorporated, as the focus of this paper is broadly on the processes involved. GRB as an innovation has four specific components: knowledge processes and networking, institutional mechanisms, learning processes and building capacities, and public accountability and benefit incidence. The paper analyzes these four components of GRB in the context of India. The National Institute of Public Finance and Policy has been the pioneer of gender budgeting in India, and also played a significant role in institutionalizing gender budgeting within the Ministry of Finance, Government of India, in 2005. The Expert Committee Group on “Classification of Budgetary Transactions” makes recommendations on gender budgeting—Ashok Lahiri Committee recommendations—that will become part of the institutionalization process, integrating the analytical matrices of fiscal data through a gender lens and also the institutional innovations for GRB. Revisiting the 2004 Lahiri recommendations and revamping the process of GRB in India is inevitable, at both ex ante and ex post levels.
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Working Paper No. 785 | January 2014
Empirical Description of Gender-specific Outcomes and Budgeting
Incorporating time in public policymaking is an elusive area of research. Despite the fact that gender budgeting is emerging as a significant tool to analyze the socioeconomic impacts of fiscal policies and thus identify their impacts on gender equity, the integration of time-use statistics in this process remains incomplete, or is even entirely absent, in most countries. If gender budgeting is predominantly based on the index-based empirical description of gender-specific outcomes, a reexamination of the construction of the gender (inequality) index is needed. This is necessary if we are to avoid an incomplete description of the gender-specific outcomes in budget policymaking. Further, “hard-to-price” services are hardly analyzed in public policymaking. This issue is all the more revealing, as the available gender-inequality index—based on health, empowerment, and labor market participation – so far has not integrated time-use statistics in its calculations. From a public finance perspective, the gender budgeting process often rests on the assumption that mainstream expenditures, such as public infrastructure, are nonrival in nature, and that applying a gender lens to these expenditures is not feasible. This argument is refuted by time budget statistics. The time budget data reveal that this argument is often flawed, as there is an intrinsic gender dimension to nonrival expenditures.
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Working Paper No. 748 | January 2013
Evidence from India
The effectiveness of public spending remains a relatively elusive empirical issue. This preliminary analysis is an attempt, using benefit incidence methodology, to define the effectiveness of spending at the subnational government level in India’s health sector. The results reveal that the public health system is “seemingly” more equitable in a few states, while regressivity in the pattern of public health-care utilization is observed in others. Both results are to be considered with caution, as the underdeveloped market for private inpatient care in some states might be a factor in the disproportionate crowding-in of inpatients, making the public health-care system simply appear more equitable. However, patients “voting with their feet” and choosing better, private services seems evident only in the higher-income quintiles. Results also suggest that polarization is distinctly evident in the public provisioning of health-care services, though more related to inpatient, rather than ambulatory, services.
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Working Paper No. 744 | December 2012
Empirical Evidence on Fiscal Deficit – Interest Rate Linkages and Financial Crowding Out
Controlling for capital flows using the high-frequency macro data of a financially deregulated regime, this paper examines whether there is any evidence of the fiscal deficit determining the interest rate in the context of India. The period of analysis is FY 2006–07 (April) to FY 2011 (April). Contrary to the debates in policy circles, the paper finds that an increase in the fiscal deficit does not cause a rise in interest rates. Using the asymmetric vector autoregressive model, the paper establishes that the interest rate is affected by changes in the reserve currency, expected inflation, and volatility in capital flows, but not by the fiscal deficit. This result has significant policy implications for interest rate determination in India, especially since the central bank has cited the high fiscal deficit as the prime reason for leaving the rates unchanged in all of its recent policy announcements. The paper analyzes both long- and short-term interest rates to determine the occurrence of financial crowding out, and finds that the fiscal deficit does not appear to be causing either shorts and longs. However, a reverse causality is detected, from interest rates to deficits.
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Working Paper No. 590 | March 2010
Determining Gender Equity in Fiscal Federalism: Analytical Issues and Empirical Evidence from India
View More View LessDespite the policy realm’s growing recognition of fiscal devolution in gender development, there have been relatively few attempts to translate gender commitments into fiscal commitments. This paper aims to engage in this significant debate, focusing on the plausibility of incorporating gender into financial devolution, with the Thirteenth Finance Commission of India as backdrop. Given the disturbing demographics—the monotonous decline in the juvenile sex ratio, especially in some of the prosperous states of India—there can be no valid objection to using Finance Commission transfers for this purpose. A simple method for accomplishing this could be to introduce some weight in favor of the female population of the states in the Commission’s fiscal devolution formula. The message would be even stronger and more appropriate if the population of girl children only—that is, the number of girls in the 0–6 age cohort—is adopted as the basis for determining the states’ relative shares of the amount to be disbursed by applying the allotted weight. A special dispensation for girls would also be justifiable in a scheme of need-based equalization transfers. While social mores cannot be changed by fiscal fiats, particularly when prejudices run deep, a proactive approach by a high constitutional body like the Finance Commission is called for, especially when the prejudices are blatantly oppressive. Indeed, such action is imperative. The intergovernmental transfer system can and should play a role in upholding the right to life for India’s girl children. That being said, it needs to be mentioned that it is not plausible to incorporate more gender variables in the Finance Commission’s already complex transfer formula. In other words, inclusion of a “gender inequality index” in the formula may not result in the intended results, as the variables included in the index may cancel one another out. Accepting the fact that incorporating gender criteria in fiscal devolution could only be the second-best principle for engendering fiscal policy, the paper argues that newfound policy space for the feminization of local governance, coupled with an engendered fiscal devolution to the third tier, can lead to public expenditure decisions that correspond more closely to the revealed preferences (“voice”) of women. With the 73rd and 74th constitutional amendments, this policy space is favorable at the local level for conducting gender responsive budgeting.
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Working Paper No. 536 | July 2008
Evidence from a Time-use Survey for the Water Sector in India
This paper presents new evidence on the links between public-infrastructure provisioning and time allocation related to the water sector in India. An analysis of time-use data reveals that worsening public infrastructure affects market work, with evident gender differentials. The results also suggest that access to public infrastructure can lead to substitution effects in time allocation between unpaid work and market work. The broad conclusion of the paper is that public-investment policy can redress intrahousehold inequalities, in terms of labor-supply decisions, by supporting initiatives that reduce the allocation of time in nonmarket work.
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Working Paper No. 518 | October 2007
Evidence from an Asymmetric VAR Model
This paper analyzes the real (direct) and financial crowding out in India between 1970–71 and 2002–03. Using an asymmetric vector autoregressive (VAR) model, the paper finds no real crowding out between public and private investment; rather, complementarity is observed between the two. The dynamics of financial crowding out is captured through the dual transmission mechanism via the real rate of interest—that is, whether private capital formation is interest-rate sensitive and, in turn, whether the rise in the real rate of interest is induced by a fiscal deficit. The study found empirical evidence for the former but not the latter, supporting the conclusion that there is no financial crowding out in India. The differential impacts of public infrastructure and noninfrastruture innovations on the private corporate sector are carried out separately to analyze the nonhomogeneity aspects of public investment. The results of the Impulse Response Function reinforced that no other macrovariables, including cost and quantity of credit and the output gap, have been as significant as public investment—in particular, public infrastructure investment—in determining private corporate investment in the medium and long terms, which has crucial policy implications.
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