Is Public Debt Sustainable in Himachal Pradesh? Evidence from a Fiscal Reaction Function Approach

ABSTRACT : This study examines the sustainability of public debt in Himachal Pradesh using a Fiscal Reaction Function (FRF). It evaluates whether the state government’s primary balance is adjusted in response to changes in debt, using annual data for the period 2004-05 to 2023-24. The baseline model is estimated using ordinary least square (OLS) and is extended to incorporate macroeconomic conditions through output gap and structural shock through COVID-19 dummy variable. The results show a positive and statistically significant response of primary balance to lagged debt across model specifications, suggesting that fiscal policy has been responsive to rising debt levels. The inclusion of output gap and COVID-19 does not alter core relationship, rather it strengthens the evidence that fiscal behaviour is largely structural and not event driven. The study also examines debt stabilisation condition using interest rate – growth differentials and finds out that macroeconomics condition has been favourable for maintaining stable debt trajectory. There is no evidence of fiscal fatigue over the sample period. However, these findings are interpreted in the context of institutional support through the revenue deficit grant (RDG), which are no longer continued by Finance Commission. Overall, the result suggests that public debt in Himachal Pradesh has followed a broadly sustainable path during the study period, although maintaining this will depend on continued fiscal discipline and favourable macroeconomic conditions.