Page 76 - ES 2020-21_Volume-1-2 [28-01-21]

Does Growth Lead to Debt Sustainability? Yes, But Not Vice-Versa! 59

2.14 To infer the direction of causation, we examine the differences in their lagged correlations.
Figure 8 demonstrates the lagged relationship between real GDP growth rates and change in
general government debt-to-GDP levels over the last 25 years. Over the last two-and-a-half
decades, real GDP growth rates and one-year-ahead change in general government debt-to-
GDP levels show a significant negative correlation. However, during the same time period,
the correlation between change in general government debt-to-GDP levels and one-year-ahead
growth rates turns out to be statistically indistinguishable from 0. The evidence therefore shows
the direction of causality between the two variables: higher growth leads to lower public debt in
India, but not vice-versa.

Figure 8: Direction of causality between growth and change in GG debt
for india (FY 1996 to FY 2020)
Figure 8a: Growth → Debt : Correlation Figure 8b: Debt → Growth : Correlation
between g and 1 year ahead ∆d between ∆d and 1 year ahead g

Source: RBI, MoSPI
Note: d-General Government Debt-to-GDP ratio (per cent)
GDP 2011-12 series used
Debt used for 2018-19 is RE and 2019-20 is BE

Box 5: Debt Sustainability through higher growth following
the Asian Financial Crisis

Across economic crises over the last century, fiscal policy has been a prominent savior to bring
back economic growth. For the past three decades, the Indian economic story has been characterized
by long spells of high GDP growth. Fiscal policy has been a key determinant of growth acceleration
after an exogenous global shock led to a decline in growth. Consider the shock due to the Asian
Financial Crisis (1997-98). During the period 1997-98 to 2002-03, growth slowed down to an
average of 5.3 per cent in real terms. Despite a fall in growth levels, an expansionary fiscal policy
1
that focused on infrastructure spending was adopted by the Government

1 This was combined with several reform measures that helped enhance productivity. Martin, Natarajan and Harrison 2017
show that removal of small scale reservations during early 2000s encouraged the overall employment growth and productivity
of firms which were earlier consrainted by the size restrictions. On the other hand, the policy direction following the Global
Financial Crisis was in stark contrast to that following the Asian Financial crisis. While fiscal spending was stepped up after
the GFC, the quality of spending remained poor. Moreover, absence of reforms exacerbated the poor quality fiscal spend.
(Bajpai, 2011)