ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

Rajan GoyalSubscribe to Rajan Goyal

States' Debt and Debt Relief

The deterioration in the fiscal performance of the states since the mid-1980s is reflected in all major indicators, viz, fiscal deficit, revenue deficit and debt-GDP ratio. In this paper, a baseline scenario is generated under some assumptions to ascertain the dimensions of fiscal balance at present, and the likely trends in the medium term. Three sets of alternative policy scenarios are also generated, by superimposing alternative assumptions over the baseline scenario, to assess and prescribe policy initiatives. It is inferred that lowering the primary deficit, besides a reduction in interest rates, should be an integral part of any policy to make debt sustainable at the state level. An immediate focus of the fiscal reforms should be on achieving revenue balance or, at least reducing its imbalance.

Does Higher Fiscal Deficit Lead to Rise in Interest Rates?

The relationship between fiscal deficit and the rate of interest is still an unsettled issue. Theoretically, at least in neo-classical sense, funding of government requirements through market borrowings would not only induce rise in interest rates, but the increased funding cost in turn would also contribute to the rise in fiscal deficit. In the Indian context, the coexistence of falling interest rates and growing size of fiscal deficit in the recent years, however, seems to suggest that the causation between the two does not hold. Further, there is empirical evidence suggesting one-way causality running only from real interest rate to fiscal deficit. This paper re-examines this issue and argues that the absence of an apparent fiscal impact on interest rate is essentially the result of higher liquidity in the system. Empirical results drawn through a VAR model show that there is a two-way causality between gross fiscal deficit and the real interest rate.
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