ECONOMIC LIBERALIZATION, FISCAL PERFORMANCE,

GOVERNMENT DEBT AND TAX REFORMS: INDIAN EXPERIENCEProf. Prashant Kulkarni

Asst. Professor, International Business and Economics, Indian Business Academy, Bangalore.

Prof. Anantha Murthy N.K.Asst. Professor, Quantitative Methods and Operations

Research, Indian Business Academy, Bangalore.

OBJECTIVES

Examining the determinants of fiscal policy

Understanding the implications of Tax/GDP ratio on the country’s growth

Explore how size of public debt can have an impact on tax structure

Move in direction of understanding the degree to which various determinants influence fiscal deficit.

REVIEW OF LITERATURE

Dr. C Rangarajan former Governor, RBI and Dr. Srivatsava (2003), shows that four fifths of the effects of public indebtedness was negated on account GDP growth being faster than real interest rates.

Surajit Das (2004) tested the empirical relationship between higher interest rates and deficits. He concluded that the theoretical arguments favoring the co-relation between the deficits and the interest rates rest on the assumption of full employment.

Ricardo Hausmann of Harvard and Catriona Purfield (2002) contend that inflation benefits the economy by ensuring the solvency of public debt.

Subir Gokarn (2004) feels that the fragile fiscal situation was hindering the growth of the economy. While FRMB requires the government to reduce the fiscal deficit by 0.3% per year, it feasibility hinged on the sustaining high growth rates apart from the extent of success in broadening of the tax base.

Swaminathan Aiyar (2004) feels that it is the trade invisibles that have cushioned the impact of fiscal deficit in India. Net invisibles that were under $2 billion in the early 1980s, shot up to nearly $20 billion by the end of 2003. The figure for 2003 represented nearly 4% of the GDP and this offset the impact of the deficit.

Easterly and Schmitt-Hebbel (1994) estimate the relation between fiscal deficit and inflation. They conclude that seignorage is not an important as a steady state phenomenon but can be important in short run period.

METHODOLOGY

The study uses secondary data from various sources like Budget documents, RBI reports, reports from CRISIL, data published by Central Statistical Organization etc. We analyzed various determinants of fiscal deficit. The study makes use of the data for Indian fiscal parameters using the Multiple Regression model. We subject the data with tests for auto-correlation and multicollinearity.

 

HYPOTHESIS FOR TESTING

H0: There is no impact of government borrowings, revenue expenditure and foreign exchange reserves on Fiscal deficit of India as measured by fiscal deficit as percentage of GDP

H1: There is an impact of government borrowings, revenue expenditure and foreign exchange reserves on Fiscal deficit of India as measured by fiscal deficit as percentage of GDP

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

MULTIPLE REGRESSION MODEL RESULTS

Multiple correlation coefficient

Co-efficient of determination

Estimate of error

0.9355 0.8752 0.5339

ANOVA

Source d o f SS MS F p-value

Explained 8 33.9964 4.2495 14.9067 0.0000**

Unexplained

17 4.8463 0.2851

* INDICATES 5% STATISTICAL SIGNIFICANCE** INDICATES 1% STATISTICAL SIGNIFICANCE

Coefficient Standard Error t-value p-value

Constant 4.9575 2.8402 1.7454 0.099

money supply (M3) 0 0 2.3453 0.0314*

Debt GDP -0.1254 0.0754 -1.6622 0.1148

Tax GDP -0.9794 0.4263 -2.2978 0.0345*

Rev exp 1.6118 0.5318 3.0309 0.0075**

Forex 0 0 -1.6149 0.1247

Cap exp -0.7571 0.6011 -1.2595 0.2249

Rev Deficit -0.1375 0.298 -0.4614 0.6503

Government borrowing

0 0 -1.1725 0.2572

CORRELATION BETWEEN INDEPENDENT VARIABLES

money supply

Debt GDP Tax GDP Rev exp Forex Cap exp Rev Deficit Govt borrowing

money supply

1.000 0.772 0.056 -0.448 0.965 -0.762 0.584 0.926

Debt GDP 1.000 0.411 0.079 0.730 -0.533 0.681 0.720

Tax GDP 1.000 0.513 0.172 0.254 -0.220 -0.172

Rev exp 1.000 -0.397 0.729 -0.111 -0.405

Forex 1.000 -0.621 0.389 0.823

Cap exp 1.000 -0.694 -0.771

Rev Deficit 1.000 0.751

Govt borrowing

1.000

coefficient of determination is 0.8752 and VIF =8.01 which is less than 10. This show even though few independent variables are strongly correlated multicollinearity will not be problem for the model.

DURBIN WATSON TEST

Positive autocorrelationRejecting Ho

Inconclusive No autocorrelationAccept Ho

dl =0.8156

du=2.1172

GRAPH OF FISCAL DEFICIT AS PERCENTAGE OF GDP AND FITTED VALUES

1980

-81

1981

-82

1982

-83

1983

-84

1984

-85

1985

-86

1986

-87

1987

-88

1988

-89

1989

-90

1990

-91

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-00

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

0

2

4

6

8

10

12

FiscaldeficitFitted Values

Financial years

Fiscal deficit as a per-cent of GDP

INFERENCES

Rising revenue expenditure is a cause for concern. With government spending on interests and increased salaries unlinked with

productivity, revenue expenditure shows a rising trend without fetching any returns.

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 tax

collections will erode the government revenues forcing it go in for deficit financing. Since deficit financing is advocated by many economists, we tested impact of capital expenditure on fiscal deficit. We find no evidence of it having an impact on fiscal deficit as % of GDP.

We also find evidence of impact of money supply on fiscal deficit. It has been established that increased deficit causes a rise in money supply leading to inflationary trends (RBI economic report 2009).

Some studies (Swaminathan Aiyar, 2004) believed that increased foreign exchange reserves were cause of cushioning the impact of fiscal deficit. While we do not find any impact of foreign exchange reserves on the deficit, we have to go deeper to understand the linkages between the two.

The study was an attempt to understand the dynamics of Indian fiscal policy and the impact of various factors on fiscal deficit as percentage of GDP. Our results seem consistent with the existing literature on the subject.

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 of Finance,

Government of India, June 2003 Indira Rajaraman, “Fiscal Restructuring in the Context of Trade Reform”, National Institute of Public Finance

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 of India

2004 Subir Gokarn “CRISIL Report on Economic Impact” 2004 M Govinda Rao, “Tax Systems Reform in India: The Center State Dimension”, A Presentation by National

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, July 2004 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 Economic Affairs, 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  

Thank you

Questions?