Fiscal sustainability in India: evidence from Markov switching and threshold regression models

Abstract

Purpose The purpose of this study is to examine the fiscal sustainability issue by dividing the fiscal deficit into high and low regimes using the quarterly data from 1997: Q1 to 2013: Q3. Further, we obtain the optimum level of public debt at which fiscal sustainability can be achieved. Design/methodology/approach This study uses the Markov Switching-Vector Error Correction Model (MS-VECM) for examining fiscal sustainability and threshold regression model to obtain the optimum level of debt. Findings The results derived from MS-VECM reveal the evidence in favor of fiscal sustainability during low fiscal deficit periods. Similarly, using a threshold regression model, the optimum public debt as a percentage to GDP seems to be around 21 per cent on a quarterly basis, beyond this level, public debt hurts economic growth. Practical implications From the policy front, the government of India should cut down the fiscal deficit only if debt reaches beyond a threshold level. Originality/value Noting that the vast literature has focused on examining the fiscal sustainability in India, the novelty of this study is to examine the fiscal sustainability by considering high and low deficits regimes using a non-linear approach.