Causal Nexus between Public Debt and Economic Growth: The Case of India

Abstract

The aim of this paper is to investigate the important issue of “cause-effect” relationship between public debt and economic growth for Indian economy over the period of 1980-81 to 2013-14. The statistical description provides evidence that the causal issue between these variables is undefined and inconclusive.  To address this irresolvable issue, this paper employs the time series techniques like unit root test (ADF and PP), VAR lag selection criteria, Johansen cointegration test, VECM, and VEC granger causality test. The application of Johansen test on first order integrated variables like domestic debt, external debt and economic growth substantiates the presence of long-run cointegration among these variables. Besides, in the VECM model, the statistically significant and negative coefficient of error correction term in external debt equation represents the restoring of the long run equilibrium at the rate of 11.34 percent every year between external debt and growth.  Moreover, the testing of the causality unveils the fact that there is no causal relationship between domestic debt and economic growth but a unidirectional causality exists from economic growth to external debt both in a short run and in a long run. Therefore, these empirical results suggest that reliance on debt for development purposes is not a safe option, even though the presence of no feedback relationship between the said variables. So, Indian economy should extend its efforts to increase the revenue to finance the development expenditure.

JEL Classification: H63, O40, E43, F34

Keywords: Public debt, Economic growth, Domestic debt, External debt