Fiscal deficit and its long run impact on capital formation in India

Background: Fiscal policy has long been considered as a vital instrument for economic growth and stability; yet, the increasing fiscal burden arising from deficit financing raise serious concerns, especially in developing nations like India.The significance of deficit financing as a policy measure to enhance investment has been examined using the proxies of fiscal deficit and capital formation. Materials and Methods:The study utilized time series data for analysis, employing techniques such as Unit Root Tests, Johansen Cointegration, Granger Causality, Variance Decomposition, and Impulse Response Function to derive valuable insights.Results: Fiscal deficit of state and general government increased significantly during the study period.However, econometric tests show no long-term or casual association between fiscal deficits and capital formation.Variance decomposition indicates that both variables explain their own variations. Conclusions:The optimum level of fiscal spending must be determined to prevent excessive burden on the economy.