Does Debt-Deficit sustainability exist at subnational level in India? An empirical exploration

In this paper, an attempt has been made to empirically examine the presence, or otherwise, of long-run sustainability between Fiscal Deficit, Public Debt and Interest Payments among 17 major Indian states. For accomplishing the objective, we have resorted to two distinct approaches, based on (a) Domar's (1944) model, and (b) Panel cointegration analysis among the study aggregates. As per the former approach, states like Assam, Bihar, Kerala, Karnataka, Rajasthan, Tamil Nadu, Uttar Pradesh, and West Bengal have failed to maintain debt-deficit fiscal sustainability. As per the panel cointegration analysis, the five broad aggregates of Debt, Deficit, Interest, Expenditure and Income among the Indian states were tested to have borne long-run steady-state equilibrium relationship and, that, there was a strong indication of bi-directional causality between Public Debt and Fiscal Deficit. Further, the results from panel vector autoregression (VAR) analysis have revealed Public Debt to be strongly linked with its own past values, as well as with the past values of each of Fiscal Deficit, Interest Payments and Servicing of Debt and GSDP Deflator. The results are thus indicative of the major Indian states to have remained trapped in a vicious circle of debt, deficit, interest payments and inflationary pressure.