Government Debt and Economic Growth in India

Anirudha Barik
Ph.D Scholar
Centre for Economic Studies and Planning (CESP)
Jawaharlal Nehru University (JNU)
New Delhi

ABSTRACT
India after independence opted for a path of economic development based on centralized planning with a leading
role assigned to the public debt on the consideration that it shall be used for planned investment to achieve rapid
economic growth. Although the traditionalist viewed negative relationship between public debt and economic
growth while the Ricardian viewed the government debt is considered equivalent to future taxes which implies the
neutrality of debt to growth. Given the current drive towards incurring debt, this study examines how government
debt in India may influence country’s economic growth? Previous research on this question has primarily focused on
the direct relationship between public debt and economic growth. By contrast, it has put less important on the
indirect effects of public debt on economic growth. Therefore the present study gives an examination of the
potential indirect influence of public debt on economic growth through its impact on investment. The issue is
empirically examined using an augmented Solow (1956) neoclassical model of economic growth that allows for
both the direct and indirect effects of public debt on economic growth. The econometric investigation, using annual
data series for the period of 1981-2011, offers strong evidence that there is an indirect connection between public
debt and economic growth in India. Public debt appears to be positively related to both investment and output
growth and thus has an indirect positive effect on economic growth through its positive influence on investment.

Keywords: Public Debt, Investment and Economic Growth

JEL Codes: E22, H63, O40

1
1. Introduction

India after independence opted for a path of economic development based on centralized
planning with a leading role assigned to the public debt on the consideration that it shall be
used for planned investment to achieve rapid economic growth. Given the current drive
towards incurring public debt, it is important to ask how public debt may influence economic
growth. What evidence exists on the direct relationship between public debt and economic
growth is conflicting at best and lacks for the most. The same may be said for the theoretical
development and empirical evidence on the relationship between public debt and investment
and the indirect effect of public debt on economic growth through investment. If public debt
negatively influences economic growth directly or indirectly then policymakers need to be
aware of these relationships when formulating and implementing macroeconomic policy. On
the other hand, if debt enhances economic growth, or at a minimum does not present
obstacles to capital formation and hence growth, the case for public debt is strengthened and
policymakers need to focus their attention on the potential influences of public debt. However,
it is important for overall macroeconomic policy to manage the debt and it needs to be
coordinated closely with fiscal, monetary and other macroeconomic policies. In this connection
an attempts has been made to correlate the public debt to economic development.

Furthermore, the relationship between public debt and economic growth is a much debated
issue. There is no agreement among economists either on analytical grounds or on the basis of
empirical results whether financing government expenditure by incurring debt is good, bad or
neutral in terms of its real effects, particularly on investment and growth. Among the
mainstream analytical perspectives, the classicists viewed public debt as burden to the society;
the neoclassical view considers public debt detrimental to investment and growth, the
Ricardian views government debt is considered equivalent to future taxes (Barro 1974) which
implies neutrality of debt to growth; but in the Keynesian paradigm, it constitutes a key policy
prescriptive. While the neoclassical and Ricardian schools focus on the long-run, the Keynesian
view emphasises the short-run effects.

In light of the above theoretical backdrop, this paper makes an attempt to analyze weather
public debt has direct impact on capital formation (investment) and on economic growth?
Finally, whether the public debt has a potential indirect influence on economic growth through
its impact on investment, i.e. to examine the proposition that the static efficiency of public debt
have a corresponding dynamic effect in the arena of economic growth?

In this paper, the term or the concept ‘government debt’ is defined as the total of liabilities of
Government of India to include domestic liabilities and external liabilities. The functional
budgetary classification of ‘domestic liabilities’ includes internal debt, small savings, deposits
and provident funds, reserve funds and deposits and other liabilities. The items under the head
‘internal debt’ relates mostly to borrowing through market loans, treasury bills, special
securities issued to RBI, special bearer bonds and other bonds, and securities issued to
international financial institutions. The sum of internal and external debt is officially called
public debt. Moreover, public debt in India may be defined to include internal and external

2
debts of central government, state governments and union territory governments, local
authorities and public undertakings - financial as well as non-financial. Other liabilities include
borrowing through small savings, provident funds, and reserve funds and deposits. In this paper
we shall confine ourselves to measurement of total debt of government of India measured at
current prices and at book values of government bonds and securities.

The specific objectives of the paper are first to analyze the trend and patterns in government
debt, and its relationship with investment and growth in India since 1981, second to account
for the direct relationship between government debt and economic growth, and third to
incorporate the potential influence of government debt on investment into the aggregate
production function; and therefore examine the indirect influence of government debt on
economic growth through its impact on investment. To fulfill the first and second objective
information on government debt and other macro variables have been collected from various
secondary sources like Handbook Statistics on Indian economy (RBI), Economic Survey (GOI),
Budget Documents (GOI) and Indian Public Finance Statistics (GOI). Third objective is fulfilled by
using an augmented Solow (1956) neoclassical model of economic growth that allows for both
the direct and indirect effects of government debt on economic growth.

The paper has been organized in 5 sections. Section 2 presents brief review of literature on the
relationship between debt and economic growth. Section 3 analyzes the trends in government
debt and other macro variables in question. In section 4 we develop an augmented neoclassical
model of economic growth that incorporates the potential indirect effect of debt on economic
growth through investment and the direct effect on economic growth. A sub-section to this,
presents the data sources and specification of econometric model along with results. Section 5
ends with a few concluding remarks with some policy implications from this current knowledge
of the issues.

2. Review of Literature

The relationship of public debt with economic growth is well discussed in the international
research studies but the relationship between public debt and economic growth in Indian
context is not very much focused. At the outset the brief review of public debt and economic
growth is given. Singh (1999) explored the relationship between domestic debt and economic
growth in India by applying co integration technique and Granger causality test for the period of
1959-95. The study supported the Ricardian Equivalence Hypothesis between domestic debt
and growth in India. Sheikh et al. (2010) studied the impacts of domestic debt on economic
growth and also observed the impact of domestic debt servicing on economic growth in
Pakistan by applying the OLS technique for the period of 1972 to 2009. The study indicated that
the negative impact of domestic debt servicing on economic growth is stronger than positive
impact of domestic debt on economic growth. Uzochukwus (2003) investigated the quantitative
effects of public debt (domestic and external) and economic growth on poverty in Nigeria by
applying the per-capita income approach using annual data of 1970 to 2002. Maana et al (2008)
analyzed the economic impact of domestic debt on Kenya’s economy by applying ordinary least
square technique and modified Barro growth regression model through annual data over the

3
period 1996 to 2007. Muhdi and Sasaki (2009) examined the roles of external and domestic
debt in Indonesia’s macroeconomic situation by applying ordinary least square (OLS) estimation
for the period 1991 to 2006. The study showed the positive effects of the rising trend of
external debt on both investment and economic growth. Adoufu and Abula (2009) investigated
the effects of rising domestic debt on the Nigerian economy, by applying OLS technique, using
time series data from 1986-2005. The analysis showed that domestic debt had negatively
affected the growth of the economy. The study recommends that government should made
efforts to resolve the outstanding domestic debt.

Checherita and Rother (2010) determined the average impact of government debt on per
capita GDP growth for twelve euro area countries over a period of about 40 years from 1970-
2009. The study showed non-linear negative impact of government debt on economic growth.
Kumar and Woo (2010) studied the impact of high public debt on long-run economic growth for
a panel of advanced and emerging economies over 1970-2007. Their empirical results suggest
an inverse relationship between initial debt and subsequent growth: on average, a 10
percentage point increase in the initial debt-to-GDP ratio is associated with a slowdown in
annual real per capita GDP growth of around 0.2 percentage points per year, with the impact
being somewhat smaller in advanced economies. Reinhart and Rogoff (2009) provided evidence
of a negative link between public debt and growth by examining economic growth at different
levels of government debt in a sample of forty-four countries spanning about two hundred
years. Fosu (1996) tested the relationship between economic growth and external debt with an
empirical study for the sample of sub-Saharan African countries over the 1970-1986 periods by
employing the OLS method. Karagol (2002) investigated the long-run and short run relationship
between economic growth and external debt service for Turkey during the 1956-1996 by using
multivariate co-integration techniques and employed a standard production function model.

The above mentioned studies show a mixed impact of public debt on economic growth. Some
studies are of the view that public debt impedes the economic growth but some are in the
opinion that public debt positively affects the economic growth.

3. Central Debt, Investment and Growth in India

An understanding of behavior of government debt is important for considering its impact on

investment and hence on growth. In this section, we look at the trends over the last three
decades (1981-2011), which span both the pre and post reform period, helps us understand the
relationship between debt and growth in Indian economy.

4
 Table-1: Debt Relative to GDP, Growth and Investment (Rs. Crore)
GDP Total Debt Debt
Public Investment
Year GDPmp Growth Central Growth Growth Investment
Debt Rate
Rate Debt Rate Rate
1981-82 178505 17.51 68186 14.1 47981 13.8 33303 18.66
1982-83 196644 10.16 84872 24.5 60621 26.3 37522 19.08
1983-84 229021 16.46 95261 12.2 65383 7.9 41756 18.23
1984-85 256611 12.05 113441 19.1 75174 15.0 49078 19.13
1985-86 289524 12.83 137484 21.2 89192 18.6 59648 20.60
1986-87 323949 11.89 166546 21.1 106611 19.5 65048 20.08
1987-88 368211 13.66 195561 17.4 121869 14.3 80532 21.87
1988-89 436893 18.65 229771 17.5 140244 15.1 99796 22.84
1989-90 501928 14.89 268192 16.7 161536 15.2 119009 23.71
1990-91 586212 16.79 314558 17.3 185529 14.9 152604 26.03
1991-92 673875 14.95 354662 12.7 209698 13.0 146907 21.80
1992-93 774545 14.94 401924 13.3 241369 15.1 178437 23.04
1993-94 891355 15.08 477968 18.9 293057 21.4 197785 22.19
1994-95 1045590 17.30 538611 12.7 317396 8.3 258561 24.73
1995-96 1226725 17.32 606232 12.6 359118 13.1 310045 25.27
1996-97 1419277 15.70 675676 11.5 398715 11.0 336125 23.68
1997-98 1572394 10.79 778294 15.2 444330 11.4 402092 25.57
1998-99 1803378 14.69 891806 14.6 516950 16.3 436521 24.21
1999-00 2012198 11.58 1021029 14.5 772691 49.5 538834 26.78
2000-01 2168652 7.78 1168541 14.4 869643 12.5 528299 24.36
2001-02 2348330 8.29 1366408 16.9 984607 13.2 571146 24.32
2002-03 2530663 7.76 1559201 14.1 1080301 9.7 627743 24.81
2003-04 2837900 12.14 1736678 11.4 1187830 10.0 762416 26.87
2004-05 3242209 14.25 1994421 14.8 1336849 12.5 1064041 32.82
2005-06 3693369 13.92 2260145 13.3 1484001 11.0 1279754 34.65
2006-07 4294706 16.28 2538596 12.3 1647691 11.0 1531433 35.66
2007-08 4987090 16.12 2837425 11.8 1920390 16.6 1900762 38.11
2008-09 5630063 12.89 3159178 11.3 2151595 12.0 1931380 34.30
2009-10 6457352 14.69 3517845 11.4 2477263 15.4 2363670 36.60
2010-11 7674148 18.84 3931105 11.7 2898799 15.2 2692031 35.08
2011-12 8912178 16.13 4352689 10.7 3281465 14.7 - -
Note: Data for 2010-11 are Revised Estimates and data for 2011-12 are Budget Estimates.
Source: Computed from the data available in Indian Public Finance Statistics, 2011-12 and Economic Survey 2011-12

Table-1 shows nominal value of Gross Domestic Product (GDP), gross total debt and public
debt, and investment for the period from 1981 to 2011. The table shows that the value of total
liabilities of GOI has increased more than 63 times between 1980-81 and 2011-12 and the
growth rate of total debt averages about 15 percent per annum during the same period. The
table also shows that public debt as a ratio to GDP has also averaged 40 percent per annum
over the entire period. The rate of investment as a ratio of GDP has risen to 35.08 percent in
2010-11 from 18.66 percent in 1981-82.

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Furthermore, the trends of debt are examined at three levels: (a) combined debt of centre and
states, (b) exclusively central debt and (c) debt of all states. The figure-1 does all these three
angles for the period 1981 to 2011.

Figure-1: Debt of Central and State Governments: As % of GDP

90
80
70
60
50
40
30
20
10
0
1981-82
1982-83
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
Total Liabilities (Centre) Total Liabilities (States) Total Liabilities (Centre & States)

The combined liability of center and states provides the true picture of India’s debt. The
combined debt of the central and state governments, which averaged 56% of GDP in the 1980s,
rose to an average of slightly over 63% in the 1990s and climbed further to touch a peak of
81.4% in 2003-2004. After 2003-04, total combined debt as a percentage of GDP has decreased
sharply may be partly due to the FRBM policies towards reducing public debt to GDP ratio in
India. Similar is the trend of debt relative to GDP position of central government. It varies from
40 percent to 63 percent during the entire period. It recorded maximum 63 percent in 2003-04
and minimum of 40 percent in 1981-82. Similar trend can also be observed in case of debt of all
states. It showed maximum 32 percent in 2003-04 and minimum 18 percent during 1980-81.

It is important to know the relationship of government debt with that of investment and
growth. Figure-2 gives an overview of trends in growth rates of total debt, GDP and investment
for the period 1981 to 2010. It can be seen that the debt position of the government has
somehow impacted the total investment of the economy in India. As a proportion of GDP,
investment rate stood at 35 percent in 2010-11. This had reached an average of 25 percent
during the entire period of 1981-2010. In the long run there would be a limit to growth of
investment and as debt amount rises. The relative growths of government debt and GDP during
the years 1981-82 to 2010-11 were about 15 and 14 percent per annum respectively.

6
 Figure-2: Total Debt, Real Growth and Investment: Annual Growth-1981-2010

40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
1981-82

1983-84

1985-86

1987-88

1989-90

1991-92

1993-94

1995-96

1997-98

1999-00

2001-02

2003-04

2005-06

2007-08

2009-10
GDP DEBT INV

Correlation and R2 Comparison

The value of R2 or coefficient of determination (CD) determines the explanatory power of the
level of debt which is used as independent variables in the regression models. The closer the
value is to 1, the higher is the explanatory power of the specific measure for the variable on the
Y-axis. The following table demonstrates R2 and correlation from each combination of variables.

Table-2: Strength of Association: Debt, Investment and Growth

DEBT
Ratios
Correlation R-square
GDP 0.99 0.47
INV 0.98 0.38
Source: Author’s own calculation using Eviews 6.0

From table-2 we observe that, in general the ratios introduced in this study is positively and
highly correlated with each other. The slight consistency to this statement is due to the fact
that the correlation between DEBT and GDP and between DEBT and INV is 0.99 and 0.98
respectively. And regarding the R2, there exist also high correlation between DEBT and GDP and
between DEBT and INV is 0.47 and 0.38 respectively.

4. The Model and the Empirics

In this section, we extended a theoretical model to examine the influence of public debt on
investment and hence on economic growth. Accordingly our objectives are first to account for
the direct relationship between public debt and economic growth, and second, to incorporate

7
the potential influence of public debt on investment into the aggregate production function;
and therefore examine the indirect influence of public debt on economic growth through its
impact on investment.

4.1. Model for Public debt, Investment and Growth

Following Mankiw, Romer, and Weil (1992), a paper on “A Contribution to the Empirics of
Economic Growth”, we developed an augmented Solow (1956) neoclassical model of economic
growth, which includes, among other variables, the accumulation of physical capital and human
capital to examine the influence of public debt and we also extended the model by assuming
that the technological progress can be disaggregated into exogenous technical progress, the
direct effect of public debt on economic growth, and the effect of public debt on investment.
By augmenting the model, we can explicitly examine how public debt may indirectly influence
economic growth through investment channel. We note that the disaggregation of the
exogenous technical progress term is consistent with the literature and adheres to the
conditional convergence hypothesis.1

We assume a Cobb-Douglas production function for the entire economy2 and so that the
production at time t is given by

ܻ௧ = ܸ௧ ‫ܭ‬௧ఈ ‫ܪ‬௧ ‫ܮ‬௧ … … . . . (1)

ఉ ଵିఈିఉ

Where, α, β > 0 and α + β < 1. Yt is output, Vt the technological progress and other institutional
factors, Lt is the labor, and Kt and Ht are the stocks of physical and human capital at time t,
respectively.

Again we define Vt as the product of the level of technology (exogenous) and other institutional
factors at time t or

ܸ௧ = ‫ܣ‬௧ ‫ܦ‬௧ ‫ܫ‬௧ … … … (2)

Where At is the level of technology (exogenous), Dt is the level of public debt, and It measures
investment or the level of capital formation. Note that Dt is synonymous with the direct effect
of public debt on output. If public debt indirectly influences output through its impact on
capital formation, citrus paribus, then it will indirectly influence economic output through It.
While the primary focuses is the indirect influence of public debt on economic growth through
its impact on investment.

We further assume that Lt and At grow exogenously at rates n and ρ, respectively3, and that the
investment (It) is a function of, among other things, public debt or

1
Barro and Sala-I-Martin, (1995)
2
Romer (1986); Barro (1990); Mankiw, Romer, and Weil (1992)

8
 ‫ܫ‬௧ = ݂ (‫ܦ‬௧ , ܼ௧ ) … … . (3)

Where, Zt is a set of control variables including economical, institutional and social variables. At
this time, for theoretical simplicity, we assume that Dt is uncorrelated with Zt.4

Let sk be the fraction of income invested in physical capital and sh be the fraction of income
invested in human capital. Thus the evolution of the economy can be determined by

݇௧ሶ = ‫ݏ‬௞ ‫ݕ‬௧ − (݊ + ߩ + ߜ )݇௧ … … … (4)

ℎ௧ሶ = ‫ݏ‬௛ ‫ݕ‬௧ − (݊ + ߩ + ߜ )ℎ௧ … … … (5)

Where y=Y/L, k=K/L and h=H/L are quantities per effective unit of labor. We are assuming that
same production function and same rate of depreciation (δ) applies to physical and human
capital. In addition, each are subject to decreasing returns to scale that no combination of
capital inputs exhibits constant returns. This implies that the economy, over the long-run, will
tend to constant physical capital-labor and human capital-labor ratios. Thus once steady state
output is achieved, additional increases in output can only be achieved through increases in
capital productivity or increases in the level of public debt (assuming that the overall effect of
public debt on economic growth is positive). From this perspective that interests us here; public
debt may affect output through two channels, a potential direct effect on output channel, and a
series of potential indirect effects, one of which is investment channel.

Now to determine the influence of public debt on economic growth, we must first determine
the steady state levels of the physical inputs specified in the production function. Equations (6)
and (7) imply that the economy converges to a steady state defined by
ଵ
‫ݏ‬௞ . ‫ݏ‬௛
ଵିఉ ఉ ଵିఈିఉ
݇∗ = ൭ ൱ … … … (6)
݊+ߩ+ߜ
ଵ
‫ݏ‬௞ఈ . ‫ݏ‬௛ଵିఈ ଵିఈିఉ
ℎ∗ = ቆ ቇ … … … (7)
݊+ߩ+ߜ
Expanding Vt and substituting (6) and (7) into the production function (equation 1) and taking
the natural logarithm gives an equation for output per capita as
α+β
ln y୲ = ln A୲ + ln D୲ + ln I୲ + lns୩ + ln s୦ − ln(n + ρ + δ) … (8)
α β
1−α−β 1−α−β 1−α−β
3
Following Mankiw, Romer, and Weil (1992), we assume that the rate of depreciation is uniform across all types of
reproducible capital for theoretical simplicity. See Lucas (1988) for alternative approaches to the question of
depreciation.
4
If debt, investment, and output were endogenously related, then we would have to modify our analysis to
incorporate the potential correlation between D and Zt. The empirical evidence to date, however, does not appear
to support the argument for an endogenous relationship between debt and investment and economic growth.

9
Thus, this equation shows how steady state per capita output depends on the accumulation of
reproducible capital, the technology, the direct effect of public debt on output, and the indirect
effect of public debt on economic growth through the investment channel.

4.2 Specification of Econometric Model for Empirical Estimation

We now turn to the task of determining whether the empirical support exists for the
hypotheses of the possible indirect effects of public debt on economic growth. Towards this
end, we employ a time series data set for the period 1981-2011 from Indian Public Finance
Statistics and Economic Survey published by Ministry of Finance, Government of India as the
primary data source.

In order to perform an in-depth analysis of the debt-investment-growth relationship, it is better

to disentangle the debt-growth nexus in a two-step relationship, in which the first is the direct
link between debt and investment, and the second is the usual growth equation. We first study
an investment model, as done, among others, by Cohen (1993)5 and Clements et al. (2003)6.

4.2.1 Model of Public Debt and Investment

Hence, the investment model is represented by equation (6) in which the dependent variable
(It) is the investment ratio.7 Following Cohen (1993) and Clements (2003), we hypothesize that
the investment rate is determined by the rate of economic growth, the growth of the money
supply, and, among things we included level of public debt.

It = β0 + β1Dt +β2Mt +β3Yt + β4Tt + β5Rt + ut.................... [6]

Where I is the investment ratio, D is the level of public debt, M is the measure of M3 as a
percentage of GDP, Y is GDP; T and R are additional control variables: openness to international
trade (as proxied by export and import, as % of GDP) and real interest rate respectively. All
these variables are expressed in logs. We also note the presence of serial correlation in the
error terms when the base equation is estimated in levels. After stationarity (if they are non-
stationary) of the observation we then could use OLS method of estimation for the relationship
between debt and investment.

The rationale of this specification lies in the expected positive effect that the degree of
openness, level of debt and the level of GDP have on investment decisions. The interest rate is
expected to have a negative impact [see, i.e. Barro and Sala-i-Martin (2004) and Cohen (1993)].

5
Cohen, Daniel, 1993, “Low Investment and Large LCD Debt in the 1980’s”, The American Economic Review, Vol. 83, No. 3
6
Clements, Benedict, Rina Bhattacharya, and Toan Q. Nguyen, 2004, “External Debt, Public Investment, and Growth in Low-
Income Countries”, IMF Working Paper No. 03/249.
7
There is no distinction between public and private investment (as in Cohen [1993], Hansen [2004]), since the debt overhang
effect should hinder both private and public investment.

10
4.2.2 Model of Public Debt, Investment and Growth

We now turn to the question of the effect of public debt on economic growth. The theoretical
model suggests that a direct relationship between public debt and economic growth is possible,
yet the question remains whether the relationship can be empirically substantiated in a fully
specified model that controls, among other things, for the indirect effect of public debt on
economic growth. Thus we specify the base equation for growth as:

Yt = β0 +β1Dt + β2It + β3Ht + β4Tt + β5PLt + ut....... [7]

Where Y, D and I are as previously discussed; and H is human capital as proxied by gross
enrolment ratio; T and PL are additional control variables: openness to international trade (as
proxied by ratio of export & import to GDP) and growth of population. All variables are
expressed in logs. As before, we note the presence of serial correlation in the error terms when
the base equation is estimated in levels. After stationarity (if they are non-stationary) of the
observation we then could use OLS method of estimation for the relationship between public
debt and economic growth.

4.3 Non-stationarity and Unit-Root Tests

Regression analysis based on time series data implicitly assumes that the underlying time series
are stationary. So the testing of stationarity is the first and foremost requirement for time
series observations before going for estimation. In time series literature, there are both formal
and informal tests of stationarity. The informal tests include time series plots and use of
correlogram. The formal tests of non-stationarity are also known as unit root test. These
include Dickey-Fuller (DF), Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) test.

4.3.1 Results of the Unit root tests

Both the Augmented Dickey Fuller (ADF), and Phillips-Perron (PP) tests are tested for all the
variables by taking null hypothesis as ‘presence of unit root’ (i.e. presence of non-sationarity)
against the alternative hypothesis ‘series is stationary’. If the absolute computed value exceeds
the absolute critical value, then we reject the null hypothesis and conclude that series is
stationary and vice-versa. The ADF and PP tests results are carried out using without trend and
with trend and depicted in Table 3 and 4.

The result in the table 3 shows that all the variables were not stationary in levels. This can be
seen by comparing the observed values (in absolute terms) of both the ADF and PP test
statistics with the critical values (also in absolute terms) of the test statistics at the 1% and 5%
level of significance. Result from the table provides strong evidence of non stationarity.
Therefore, the null hypothesis is accepted and it is sufficient to conclude that there is a
presence of unit root in the variables at levels, following from the above result, all the variables
were differenced once and both the ADF and PP test were conducted on them, the result as
shown in table 4.

11
 Table-3: Result of Unit Root Tests at Levels
LEVEL
INTERCEPT ALONE INTERCEPT+TREND
VARIABLES
ADF PP ADF PP
-4.939 -5.693 -1.880 -2.361
D
(-3.689) (-3.689) (-4.323) (-4.323)
-0.905 -0.494 -1.940 -1.470
Y
(-3.699) (-3.689) (-4.339) (-4.323)
-0.009 -0.123 -3.252 -2.534
I
(-3.689) (-3.689) (-4.415) (-4.323)
-0.153 -0.669 -3.010 -1.730
M
(-3.699) (-3.689) (-4.339) (-4.323)
0.918 0.744 -2.511 -2.623
T
(-3.689) (-3.689) (-4.323) (-4.323)
-2.235 -1.673 -2.688 -1.948
R
(-3.711) (-3.699) (-4.356) (-4.339)
-3.435 -3.588 -3.729 -3.879
H
(-3.689)* (-3.689)* (-3.580)** (-3.580)**
-6.566 -7.102 1.224 2.767
PL
(-3.689)* (-3.689)* (-4.323) (-4.323)
Note: * and ** indicates significance at 1% and 5% level respectively. Figures within parenthesis indicate critical
values. Source: Author’s Estimation using Eviews 6.0

Table-4: Result of Unit Root Tests at Differences

FIRST DIFFERENCE
INTERCEPT ALONE INTERCEPT+TREND
VARIABLES
ADF PP ADF PP
-4.207 -4.219 -6.045 -5.940
D
(-3.699)* (-3.699)* (-4.339)* (-4.339)*
-3.044 -3.052 -3.102 -3.116
Y
(-3.699)* (-3.699)* (-4.339)* (-4.339)*
-4.060 -5.922 -4.234 -5.803
I
(-3.788)* (-3.699)* (-4.467)* (-4.339)*
-3.142 -3.204 -4.631 -3.150
M
(-3.699)* (-2.976)** (-4.467)* (-3.229)**
-3.509 -3.455 -3.269 -3.206
T
(-3.699)* (-3.699)* (-3.229)** (-3.229)**
-3.369 -2.600 -3.509 -2.809
R
(-2.986)** (-2.629)** (-3.603)** (-3.233)**
-8.664 -11.021 -8.436 -11.083
H
(-3.699)* (-3.699)* (-4.339)* (-4.339)*
-0.320 -2.433 -5.974 -5.974
PL
(-3.724)* (-3.699)* (-4.339)* (-4.339)*
Note: * and ** indicates significance at 1% and 5% level respectively. Figures within parenthesis indicate critical
values. MacKinnon (1996) critical values for rejection of hypothesis of unit root applied.
Source: Author’s Estimation using Eviews 6.0

The table reveals that all the variables were stationary at first difference, on the basis of this,
the null hypothesis of non-stationarity is rejected and it is safe to conclude that the variables
are stationary. This implies that the variables are integrated of order one, i.e. I(1).

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4.4 Regression Results

Finally, the regression result of equation-[6] and equation-[7] is reported below in Table 5 and 6
respectively.

Table 5: Econometric Estimates: Impact of Debt on Investment

Variables Coefficient t-statistics p-value

Constant -0.164141 -1.616787 0.1202
Public Debt 0.849270 2.243067 0.0358
GDP 1.782963 2.828439 0.0101
Interest Rate -0.276502 -2.421436 0.0242
M3 (% of GDP) -0.11392 -0.115107 0.9095
Openness to International Trade 0.113379 0.458886 0.6510
2
R- squared (Adjusted-R ) 0.3889 (0.2778)
Durbin-Watson stat 2.2228

The table 5 shows the estimates when public debt is associated with investment. To this
objective, the most important result of the econometric estimates is the positive and
statistically significant (at 3% level) relationship between public debt and the rate of
investment. The estimated coefficient for public debt also appears to be robust to the inclusion
of other regressors; M, Y and other additional control variables such as T and R. Thus it appears
that while the public debt does not affect investment harm fully.

The other controlling variables such as GDP and interest rate have shown the expected positive
significant and negative significant relationship with the investment respectively. However, the
openness to international trade and money supply supported the expected outcomes while the
coefficients remain insignificant and thus no definite conclusion can be taken regarding their
association with public debt. And these specifications explain almost 38 percent of the variation
in the rate of investment during the sample period.

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 Table 6: Econometric Estimates: Impact of Debt on Economic Growth

Variables Coefficient t-statistics p-value

Constant -0.046372 -0.913243 0.3710
Public Debt 0.088236 2.460299 0.0231
Investment 0.110090 2.044130 0.0531
Gross Enrolment Ratio 0.554489 2.206547 0.0381
Openness to International Trade 0.131302 2.438039 0.0233
Population 2.226659 1.731784 0.0973
2
R- squared (Adjusted-R ) 0.4777 (0.3590)
Durbin-Watson stat 2.0149

The table 6 shows the estimates when public debt is associated with the economic growth. The
most important result of the econometric estimates is the positive and statistically significant
relationship between public debt and economic growth. The estimated coefficient for public
debt also appears to be robust to the inclusion of additional control regressors: T and PL. The
other controlling variables such as investment, gross enrolment ratio, openness to international
trade and growth of population have shown the expected positive and significant relationship
with the GDP growth. And these specifications explain 47 percent of the variation in growth in
the sample period.

We proved in the previous econometric estimates (Table 5) that, public debt appears to
enhance the rate investment, and in this section’s econometric estimates (Table 6) verify that a
positive relationship exists between investment and economic growth. Thus, an increase in
level of public debt, all else being equal, would appear to induce the rate of investment over
time and, in turn, indirectly enhance economic growth. We should believe that this first
evidence on the indirect influence of public debt on economic growth is intriguing as it supports
the contention that public debt has an indirect effect on economic growth through its beneficial
impact on investment.

5. Conclusion
This paper attempts to offer an indirect relationship government debt and economic growth in
India. The finding of the paper indicates that government debt has made a significant
contribution to the economic growth not only directly but also indirectly via investment,
because the public debt, all else being equal, would appear to induce investment over time
and, in turn, indirectly enhance growth in real output. If we see results of regression, it can be
noticed that public debt positively affects the economic growth, controlling for other
determinants of growth: on average, one percent point increase in debt is associated with an
increase in real GDP of around 0.08 percentage point per year. It appears that the resources
generated through public debt are basically used in a productive manner. Hence debts have
positive effects in developing economies because they are used for investment. That is why In

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India, since the beginning of planned development in 1951, the government has argued for
reliance on debt for investment purposes. Therefore the need to take measures to not just raise
public debts but to place them on a stabilize manner in the medium and long term.

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