Fiscal deficit, capital formation, and economic growth in India: a nonlinear ARDL model

Abstract

The present study made an attempt to investigate the fiscal deficit–economic growth nexus in India during 1980–1981 to 2016–2017 in the presence of gross domestic capital formation (GDCF), exchange rate, and total revenue. For empirical investigation, the study has employed auto-regressive distributed lag (ARDL) model. The empirical findings of the ARDL model provide evidence that the linear model for India’s fiscal deficit, capital formation, and economic growth dynamics would be misspecification of the model. Therefore, this study has used nonlinear auto-regressive distributed lag (NARDL) bounds testing of cointegration proposed by Shin et al. (in: Festschrift in honor of Peter Schmidt, Springer, New York, 2014) to investigate the long-run and short-run interactions between the variables. The NARDL results found the evidence of asymmetric association between fiscal deficit and GDP and GDCF and GDP in the long-term and short-term time sphere. The obtained results indicate that fiscal deficit has adverse impact on GDP, whereas GDCF has positive influence on GDP in India. This finding supports neoclassical theory regarding the nexus between fiscal deficit and economic growth. The study has suggested that, as per the “golden rule” of public finance, the amount of the fiscal deficit should be spent on capital formation in order to have a long-term multiplier effect on growth.