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Fiscal Deficit, Capital Formation, and Crowding Out : Evidence from India

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  • Lekha S. Chakraborty

Abstract

Theoretical literature identifies two variants of crowding out in an economy–real and financial. The real (direct) crowding out occurs when the increase in public investment displaces private capital formation broadly on a dollar-for-dollar basis, irrespective of the mode of financing the fiscal deficit. The financial crowding out is the phenomenon of partial loss of private capital formation, due to the increase in the interest rates emanating from the pre-emption of real and financial resources by the government through bond-financing of fiscal deficit. The paper analysed the real and financial crowding out in India during 1970-71 to 2002-03. Using asymmetric vector autoregressive model, the paper finds no real crowding out between public (in particular, infrastructure) and private investment; rather complementarity is observed between the two. The dynamics of financial crowding out is captured through the dual transmission mechanism via real rate of interest; that is, whether private capital formation is interest rate sensitive and in turn whether the rise in real rate of interest is induced by fiscal deficit. The study found empirical evidence for the former, but not the latter, reinforcing no financial crowding out in India. [NIPFP WP 43]

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Paper provided by eSocialSciences in its series Working Papers with number id:837.

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Date of creation: Feb 2007
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Handle: RePEc:ess:wpaper:id:837

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Keywords: fiscal deficit; real crowding out; financial crowding out; capital formation; bond-financing; private investment; public investment; Economics; Public finance; Indian Economy;

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Cited by:
  1. Jagadish Prasad Sahu & Sitakanta Panda, 2012. "Is private investment being crowded out in India? Some fresh evidence," Economics Bulletin, AccessEcon, vol. 32(2), pages 1125-1132.

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