Fiscal Deficit-Economic Growth Nexus in India: A Cointegration analysis

The basic aim of the study is to examine both the short run and long run relationship between fiscal deficit and economic growth in India by covering the time period from 1970-71 to 201112. Johansen Cointegration test, Granger Causality test, And Vector Error correction Model (VECM) technique are adopted in order to examine the objectives of this study. The Johansen methodology confirms the existence of long run relationship between GDP and the selected variables. The findings of the paper indicate that there is negative and significant relationship between fiscal deficit and economic growth in the long run. One percent increase in Fiscal deficit is likely to significantly decrease gross domestic product by 0.216537. But the Vector Error Correction model and Granger Causality test discards the short run relationship between fiscal deficit and economic growth. The findings of study also reveal that the negative impact of postreform fiscal deficit on economic growth is more than the impact of pre-reform’s fiscal deficit. This is contrary to Keynesian theory, but in conformity with Neo-classical theory, which holds that fiscal deficits lead to a fall in the Gross Domestic Product. The study suggests the reduction of subsidies and invests this money in health, education, infrastructure sectors such as power and roads etc., so that it will enhance the productivity of both human capital and physical capital, which will go a long way in increasing the percapita income of the people.