ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Fiscal Deficit and Rate of Interest

An Econometric Analysis of the Deregulated Financial Regime

Fiscal Deficit and Rate of Interest

This paper examines whether in the financially deregulated regime, shift in the financing pattern of the fiscal deficit away from seigniorage and external debt financing to bond financing has the probability of creating an upward pressure on the rate of interest in India. Using an asymmetric vector autoregressive model, we found that in the deregulated financial regime, the fiscal deficit did not create a rise in the interest rate. Rather, the causality runs from the exante real rate of interest to fiscal deficit. This result is in conformity with the recent trend in Indian public finance where the high interest rate fuelled the accumulation of more debt through increase in interest payments and the consequent debt-deficit spiral.

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