Fiscal dominance in India: an empirical estimation

Theoretical works have pointed at the potentially damaging impacts of fiscal dominance, i.e. fiscal authority’s profligacy being accommodated by the monetary authority. Recent scholarship have highlighted to the contrary the arguably positive effects of such accommodation under certain circumstances. Ergo, a surgical snipping of the cord of joint working of monetary and fiscal policy for all times is not advisable. This paper examined fiscal dominance in the Indian context by measuring the impact of Centre’s primary fiscal balance on real interest rates and real GDP growth rate in the Vector Error Correction Model (VECM) framework. It was observed that an improvement in fiscal balance had a positive impact on real interest rate prior to 2003, and in the subsequent periods it turned negative. With regard to the impact of primary fiscal balance on real growth rate, it was observed that the period of 1978–2003 remained a period of dominant fiscal presence and an improvement in fiscal balance—i.e. a reduction in fiscal deficit—had a positive growth effect. In the period following 2003, there was no evidence of fiscal dominance in the Indian economy.