The long‐run effect of public debt on economic growth: Evidence from India

• Published date: 01 February 2022
• Author: Anirudha Barik,Jagadish Prasad Sahu
• Date: 01 February 2022
• DOI: http://doi.org/10.1002/pa.2281

ACADEMIC PAPER

The long-run effect of public debt on economic growth:

Evidence from India

Anirudha Barik

1,2

| Jagadish Prasad Sahu

1,3

1

Centre for Economic Studies and Planning,

Jawaharlal Nehru University, New Delhi, India

2

Centre of Excellence in Fiscal Policy and

Taxation, Xavier University Bhubaneswar,

India

3

School of Business, University of Petroleum

and Energy Studies, Dehradun, India

Correspondence

Jagadish Prasad Sahu, Centre for Economic

Studies and Planning, Jawaharlal Nehru

University, New Delhi, India.

Email: sahujagadish@gmail.com

This paper examines the long run relationship between public debt and economic

growth in India for the period 1980–2018 using the autoregressive distributed lag

(ARDL) approach. The bounds test results suggest that gross domestic product (GDP)

per capita, internal and external public debt, fixed investment and trade openness are

cointegrated implying the existence of a long run equilibrium relationship between

these variables. We find that both internal and external public debt have significant

negative effect on economic growth in the long run whereas, investment has signifi-

cant positive effect on the growth rate of output per capita. The error-correction

model shows that the long run equilibrium relationship is stable and the adjustment

towards equilibrium is relatively high. Our findings suggest that too much reliance on

public debt must be discouraged since it has adverse effect on economic growth in

the long run. The government should adopt investment-supportive policies to

enhance economic growth of the country.

1|INTRODUCTION

The impact of public debt on economic growth has long been a topic

of intense debate in the academia and among the policymakers. Public

debt is often considered as an instrument to finance government

investment. In developing countries like India, public debt plays a vital

role in the economy. India after independence opted for a path of

economic development based on centralised planning with a leading

role assigned to public debt on the consideration that it could be

instrumental to achieve rapid economic growth through planned

investment. However, large amount of public debt may crowds out

private investment by raising interest rate. Policymakers need to be

aware of the effects of public debt on economic growth for effective

policy formulations. As per the recommendations of the FRBM review

committee (2017) headed by N. K. Singh, a prudent medium-term ceil-

ing for general government debt is 60% of GDP, a ceiling of 40% for

the Centre, and the balance 20% for the States. In this context, the

management of debt plays a pivotal role in stimulating economic

growth. Given the current drive towards incurring public debt, it is

important to understand the nexus between public debt and eco-

nomic growth in India.

This paper examines the long-run relationship between public

debt and economic growth in the Indian context for the period

1980–2018. We use both internal and external public debt to investi-

gate their differential effects on economic growth. The autoregressive

distributed lag (ARDL) approach—the bounds test is used to investi-

gate the presence of cointegration among the variables. We find that

GDP per capita, public debt and other control variables are coi-

ntegrated, implying a long-run equilibrium relationship between these

variables. Our results suggest that public debt has significant negative

effect on economic growth in the long run. That is to say, an increase

in public debt (both internal and external public debt) reduces eco-

nomic growth in India in the long run. The error correction model

shows that the long-run relationship is stable and the speed of adjust-

ment towards equilibrium is relative high—84 and 88% in Model-1

and Model-2, respectively. Specifically, our results indicate that 88%

of the disequilibrium in the preceding year is corrected in the

subsequent year.

This paper contributes to the literature in three important ways.

First, the present study analyses the differential effects of internal

and external debt on economic growth. Most of the studies con-

ducted on debt-related issues so far, have focused entirely on external

debt leaving out a very important part of total indebtedness that is,

domestic (or internal) debt. Second, we have considered the structural

break in GDP per capita in our analysis of the long-run relationship

between debt and economic growth. Third, this paper provides new

Received: 1 March 2020 Revised: 13 June 2020 Accepted: 9 July 2020

DOI: 10.1002/pa.2281

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https://doi.org/10.1002/pa.2281