Beyond the conditional averages: a quantile-based analysis of effects of fiscal deficits on interest rates in India

Purpose The consequences of fiscal deficit on interest rate are a debatable issue. This study examines the differential impact of fiscal deficit on quantiles of interest rates depending on the different economic conditions by utilizing monthly data from January 2004 to July 2024 in India. Design/methodology/approach This study employs quantile-Autoregressive Distributed Lag (ARDL) (Cho et al., 2015) to estimate how government borrowings affect low, median and high quantiles of interest rate. Additionally, the study uses quantile-on-quantile regression (Sim and Zhou, 2015), which considers the quantile of both a dependent and an independent variable. Findings The outcomes revealed that the association between fiscal deficit and interest rate is not consistent. Contrary to the prevailing belief that fiscal deficit and interest rates are positively related to each other, the study has found that such a relationship exists only within specific quantiles. Interestingly, a predominant negative relation exists between the two when both fiscal deficit and interest rates are high. Research limitations/implications Given that a significant association exists between fiscal policy and interest rates. The study offers evidence-based insight to policymakers by suggesting the use of regime-dependent fiscal policy rules rather than uniform strategies. The findings also propose that standard economic theories, such as neoclassical (Bernheim, 1989) and Ricardo equivalence (Barro, 1989) theory, which suggest either a positive or no link, should be employed with caution due to the presence of inconsistent effects. Originality/value The previous literature on the relationship between fiscal deficit and interest rates has primarily emphasized linearity, neglecting the potential presence of asymmetries. This study contributes to the ongoing discussion by arguing that a significant relationship exists between the two. Nonetheless, it is the economic conditions that alter the association between budget deficit and interest rates.