Are Fiscal Consolidation Episodes Conducive to Public Investment and Growth in Indian States?

This study empirically examines the effect of fiscal rules on public investment and sub-national growth using a panel of 20 major Indian states from 2011–2012 to 2023–2024. It employs regular panel data estimation procedures and the penalized spline (P-spline) technique on the expenditure response function and sub-national growth equation to map the respective effects. The results indicate that the capital outlay of state governments responds positively to high fiscal deficits, suggesting that sub-national investment in development and capital projects in Indian states as a whole is largely driven by borrowings, contributing to the economy. The growth model further underscores these implications. However, a descriptive analysis at the individual level shows a varied picture, implying that without considering states’ potential, imposing rigid limits on borrowing may impede their growth prospects. The findings may be useful to policymakers and other stakeholders to formulate appropriate strategies within the set targets or by revising the targets to ensure a specific level of public investment.