Bond financing and debt stability: theoretical issues and empirical analysis for India
AbstractThe study examines the theoretical considerations and empirical results of the switch to market borrowing, i.e. bond financing of the fiscal deficit, with correspondingly low monetisation, as part of India’s structural reforms initiated in 1991. It basically concludes that despite the sharp deterioration in State finances and persistently large market borrowing programme of the Centre, the move to market borrowings to finance the deficit is proving to be beneficial when viewed in relation to broader movements in the major fiscal variables over time. The study makes a clear distinction between the consequences of borrowing at market interest rates versus those of non-market liabilities. In preference to recent econometric approaches to test the Government’s long run debt profile, the study proposes a simple necessary condition, popularly known as the Domar condition, to evaluate the prospects for debt stability under which GDP growth should exceed the interest rate on Government debt. Based on the premises that in the long run, it is not possible to trade growth for inflation (although such a trade off may be possible in the short run) and that the central bank is unable to influence real variables (real output and real interest rates) in the long run, the study simulates different short and long run consequences of alternative combinations of bond and money financing of budget deficits on interest rates, growth, inflation, the debt-to-GDP ratio and measures of the interest burden. Empirical evaluation of the Domar debt-stability condition reveals that Central Government debt, under certain assumptions, may remain stable at prevailing levels of the primary deficit and monetised deficit. High administered rates in the Small Savings and Provident Fund Schemes, i.e., due to non-market based borrowing, however, pose problems for debt sustainability in future. The study argues that bond financing of the fiscal deficit has contributed to fiscal consolidation by inducing the Government to reduce primary expenditures. This conclusion holds even for the combined finances of the Central and State Governments. Robust evidence indicates that non-government borrowing costs have come down relative to those of the Government, and credit conditions for non-government borrowers are now easier, after the move to bond finance. Further, some evidence suggests that private capital formation has surged in recent years, contradicting the view that the anti-inflation policy of bond finance has crowded out private investment and adversely affected growth. However, the stability in market debt notwithstanding, the overall fiscal situation is critical because of potential instability in non-market debt and due to unfunded and contingent liabilities of the Central and State Governments.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 12148.
Date of creation: 10 Jun 2000
Date of revision:
bond financing; debt stability;
Find related papers by JEL classification:
- G1 - Financial Economics - - General Financial Markets
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Barro, Robert J, 1989.
"The Ricardian Approach to Budget Deficits,"
Journal of Economic Perspectives,
American Economic Association, vol. 3(2), pages 37-54, Spring.
- Wilcox, David W, 1989.
"The Sustainability of Government Deficits: Implications of the Present-Value Borrowing Constraint,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 21(3), pages 291-306, August.
- David W. Wilcox, 1987. "The substainability of government deficits: implications of the present- value borrowing constraint," Working Paper Series / Economic Activity Section 77, Board of Governors of the Federal Reserve System (U.S.).
- Khan, Mohsin S. & Reinhart, Carmen M., 1990.
"Private investment and economic growth in developing countries,"
Elsevier, vol. 18(1), pages 19-27, January.
- Reinhart, Carmen & Khan, Mohsin, 1989. "Private investment and economic growth in developing countries," MPRA Paper 13655, University Library of Munich, Germany.
- Joshua Greene & Delano Villanueva, 1991. "Private Investment in Developing Countries: An Empirical Analysis," IMF Staff Papers, Palgrave Macmillan, vol. 38(1), pages 33-58, March.
- Olivier Jean Blanchard, 1990. "Suggestions for a New Set of Fiscal Indicators," OECD Economics Department Working Papers 79, OECD Publishing.
- James D. Hamilton & Marjorie A. Flavin, 1985.
"On the Limitations of Government Borrowing: A Framework for Empirical Testing,"
NBER Working Papers
1632, National Bureau of Economic Research, Inc.
- Hamilton, James D & Flavin, Marjorie A, 1986. "On the Limitations of Government Borrowing: A Framework for EmpiricalTesting," American Economic Review, American Economic Association, vol. 76(4), pages 808-19, September.
- Blinder, Alan S. & Solow, Robert M., 1973. "Does fiscal policy matter?," Journal of Public Economics, Elsevier, vol. 2(4), pages 319-337.
- Rangarajan, C. & Srivastava, D.K., 2005. "Fiscal deficits and government debt in India: Implications for growth and stabilisation," Working Papers 05/35, National Institute of Public Finance and Policy.
- Kannan, R & Singh, Bhupal, 2007. "Debt-deficit dynamics in India and macroeconomic effects: A structural approach," MPRA Paper 16480, University Library of Munich, Germany, revised 2007.
- repec:ind:nipfwp:35 is not listed on IDEAS
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.