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Economics liberalization and fiscal performance


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The process of liberalization post 1991 paved the way for the emergence of deregulated markets in India. It represented a shift from the import substitution oriented industrialization to the export promoting industrialization. The commanding role assumed by the state in the earlier era gave way to the market dominated economy. However certain indicators of public finance remain a cause of concern. We examine the relationship between fiscal deficit, government debt and taxes in this era of economic liberalization.

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Economics liberalization and fiscal performance

  1. 1. ECONOMIC LIBERALIZATION, FISCALPERFORMANCE, GOVERNMENT DEBT ANDTAX REFORMS: INDIAN EXPERIENCEProf. Prashant KulkarniAsst. Professor, International Business and Economics,Indian Business Academy, Bangalore.Prof. Anantha Murthy N.K.Asst. Professor, Quantitative Methods and OperationsResearch,Indian Business Academy, Bangalore.
  2. 2. OBJECTIVES Examining the determinants of fiscal policy Understanding the implications of Tax/GDPratio on the country’s growth Explore how size of public debt can have animpact on tax structure Move in direction of understanding thedegree to which various determinantsinfluence fiscal deficit.
  3. 3. REVIEW OF LITERATURE Dr. C Rangarajan former Governor, RBI and Dr.Srivatsava (2003), shows that four fifths of theeffects of public indebtedness was negated onaccount GDP growth being faster than realinterest rates. Surajit Das (2004) tested the empiricalrelationship between higher interest rates anddeficits. He concluded that the theoreticalarguments favoring the co-relation between thedeficits and the interest rates rest on theassumption of full employment.
  4. 4.  Ricardo Hausmann of Harvard and CatrionaPurfield (2002) contend that inflation benefitsthe economy by ensuring the solvency of publicdebt. Subir Gokarn (2004) feels that the fragile fiscalsituation was hindering the growth of theeconomy. While FRMB requires the governmentto reduce the fiscal deficit by 0.3% per year, itfeasibility hinged on the sustaining high growthrates apart from the extent of success inbroadening of the tax base.
  5. 5.  Swaminathan Aiyar (2004) feels that it is thetrade invisibles that have cushioned theimpact of fiscal deficit in India. Net invisiblesthat were under $2 billion in the early 1980s,shot up to nearly $20 billion by the end of2003. The figure for 2003 represented nearly4% of the GDP and this offset the impact ofthe deficit.
  6. 6.  Easterly and Schmitt-Hebbel (1994) estimatethe relation between fiscal deficit andinflation. They conclude that seignorage isnot an important as a steady statephenomenon but can be important in shortrun period.
  7. 7. METHODOLOGY The study uses secondary data from varioussources like Budget documents, RBI reports,reports from CRISIL, data published by CentralStatistical Organization etc. We analyzedvarious determinants of fiscal deficit. The studymakes use of the data for Indian fiscalparameters using the Multiple Regressionmodel. We subject the data with tests for auto-correlation and multicollinearity.
  8. 8. HYPOTHESIS FOR TESTING H0: There is no impact of governmentborrowings, revenue expenditure and foreignexchange reserves on Fiscal deficit of India asmeasured by fiscal deficit as percentage of GDP H1: There is an impact of governmentborrowings, revenue expenditure and foreignexchange reserves on Fiscal deficit of India asmeasured by fiscal deficit as percentage of GDP
  9. 9. MULTIPLE REGRESSION MODEL Y=a+ b1X1+b2X2+b3X3+b4X4+b5X5+b6X6+b7X7+b8X8+ξ Where Y=Fiscal deficit X1=Money supply (M3) X2=Debt GDP X3=Tax GDP X4=Revenue Expenditures X5=Foreign Exchange Reserves X6=Capital expenditure X7=Revenue deficit X8=Government borrowings. ξ= Error term
  10. 10. MULTIPLE REGRESSION MODEL RESULTSMultiple correlationcoefficientCo-efficient ofdeterminationEstimate of error0.9355 0.8752 0.5339ANOVASource d o f SS MS F p-valueExplained 8 33.9964 4.2495 14.9067 0.0000**Unexplained17 4.8463 0.2851
  11. 11. * INDICATES 5% STATISTICAL SIGNIFICANCE** INDICATES 1% STATISTICAL SIGNIFICANCECoefficient Standard Error t-value p-valueConstant 4.9575 2.8402 1.7454 0.099money supply (M3) 0 0 2.3453 0.0314*Debt GDP -0.1254 0.0754 -1.6622 0.1148Tax GDP -0.9794 0.4263 -2.2978 0.0345*Rev exp 1.6118 0.5318 3.0309 0.0075**Forex 0 0 -1.6149 0.1247Cap exp -0.7571 0.6011 -1.2595 0.2249Rev Deficit -0.1375 0.298 -0.4614 0.6503Governmentborrowing0 0 -1.1725 0.2572
  12. 12. CORRELATION BETWEEN INDEPENDENTVARIABLESmoneysupplyDebt GDP Tax GDP Rev exp Forex Cap exp Rev Deficit Govtborrowingmoneysupply1.000 0.772 0.056 -0.448 0.965 -0.762 0.584 0.926Debt GDP 1.000 0.411 0.079 0.730 -0.533 0.681 0.720Tax GDP 1.000 0.513 0.172 0.254 -0.220 -0.172Rev exp 1.000 -0.397 0.729 -0.111 -0.405Forex 1.000 -0.621 0.389 0.823Cap exp 1.000 -0.694 -0.771Rev Deficit 1.000 0.751Govtborrowing1.000coefficient of determination is 0.8752 and VIF =8.01 which is less than 10. This show eventhough few independent variables are strongly correlated multicollinearity will not be problemfor the model.
  13. 13. DURBIN WATSON TESTPositive autocorrelationRejecting HoInconclusive No autocorrelationAccept Hodl =0.8156 du=2.1172
  14. 14. GRAPH OF FISCAL DEFICIT AS PERCENTAGE OF GDP AND FITTEDVALUES024681012FiscaldeficitFitted ValuesFinancial yearsFiscal deficit as apercent of GDP
  15. 15. INFERENCES Rising revenue expenditure is a cause for concern. With government spending on interests and increased salaries unlinked withproductivity, revenue expenditure shows a rising trend without fetching anyreturns. This in turn is having an impact on the fiscal deficit. Tax GDP ratio is also having an impact on the fiscal deficit. Any fall in taxcollections will erode the government revenues forcing it go in for deficitfinancing. Since deficit financing is advocated by many economists, we testedimpact of capital expenditure on fiscal deficit. We find no evidence of it having animpact on fiscal deficit as % of GDP. We also find evidence of impact of money supply on fiscal deficit. It has beenestablished that increased deficit causes a rise in money supply leading toinflationary trends (RBI economic report 2009). Some studies (Swaminathan Aiyar, 2004) believed that increased foreignexchange reserves were cause of cushioning the impact of fiscal deficit. Whilewe do not find any impact of foreign exchange reserves on the deficit, we haveto go deeper to understand the linkages between the two.
  16. 16.  The study was an attempt to understand thedynamics of Indian fiscal policy and the impact ofvarious factors on fiscal deficit as percentage ofGDP. Our results seem consistent with the existingliterature on the subject.
  17. 17. REFERENCES “State of the Economy”, CII Report, October 2002. Macro Economic Aggregates Published by Dept. of Economic Affairs, Ministry of Finance, 2003 Historical Economic Data 1951-2003, Published by Ministry of Statistics, 2003 “India’s External Debt: Status Position”, Publication by Dept. of Economic Affairs, Ministry ofFinance, Government of India, June 2003 Indira Rajaraman, “Fiscal Restructuring in the Context of Trade Reform”, National Institute of PublicFinance and Policy, 2003 Tax Collection figures, 2003, released by Ministry of Finance Indian Public Finance Statistics 2003-04, Dept. of Economic Affairs, Ministry of Finance, Government ofIndia 2004 Subir Gokarn “CRISIL Report on Economic Impact” 2004 M Govinda Rao, “Tax Systems Reform in India: The Center State Dimension”, A Presentation byNational Institute of Public Finance and Policy Medium term Fiscal Indicators, released by Ministry of Finance, 2004 “Implementation of Fiscal Responsibility and Budget Management Act 2003”, Report of Task Force, July2004 Andy Mukherjee, “India’s Ballooning Public Debt Gets a Breather”, Bloomberg News, October, 2005 Jayanthi Ghosh, “The Economic Case for Employment Guarantee”, Business Line, October 27,2004 Gross Domestic Product by Economic Activity Figures released by Dept. of EconomicAffairs, Government of India, 2005 Economic and Financial Data, National Summary Data Page, Ministry of Statistics, 2005 “Finding India’s Nemo:a Low Tax-GDP Ratio”, Financial Express, February 8,2005