Fiscal Deficit, Capital Formation, and Crowding Out in India

This paper analyzes the real (direct) and financial crowding out in India between
1970–71 and 2002–03. Using an asymmetric vector autoregressive (VAR)
model, the paper finds no real crowding out between public and private investment;
rather, complementarity is observed between the two. The dynamics of financial
crowding out is captured through the dual transmission mechanism via the real
rate of interest—that is, whether private capital formation is interest-rate
sensitive and, in turn, whether the rise in the real rate of interest is induced
by a fiscal deficit. The study found empirical evidence for the former but not
the latter, supporting the conclusion that there is no financial crowding out
in India. The differential impacts of public infrastructure and noninfrastruture
innovations on the private corporate sector are carried out separately to analyze
the nonhomogeneity aspects of public investment. The results of the
Impulse Response Function reinforced that no other macrovariables, including
cost and quantity of credit and the output gap, have been as significant as public
investment—in particular, public infrastructure investment—in determining
private corporate investment in the medium and long terms, which has crucial
policy implications.