Fiscal Deficit and Term Structure of Interest Rate Links on Corporate Investment: Analyzing the Post-Pandemic Monetary Policy Transmission Using Indian High Frequency Data

Lekha S. Chakraborty and C. Prasanth

Economics Working Paper Archive from Levy Economics Institute

Abstract: Using high-frequency macro data from a financially deregulated regime, this paper examines whether there is any evidence of financial crowding out in India. The macroeconomic channel through which financial crowding out occurs is the link between the fiscal deficit and the interest rate determination. The results revealed that the fiscal deficit does not significantly determine interest rates in the post-pandemic monetary policy stance in India. The long-term interest rates were strongly influenced by the short-term interest rates, a fact which reinforces that the term structure is operating in India. The results further revealed that long-term interest rates were also positively influenced by capital flows and inflation expectations, while inversely impacted by the money supply. These inferences have policy implications on the fiscal and monetary policy coordination in India, where it is crucial to analyze the effect of a high-interest-rate regime on public corporate investment. Our results showed that public infrastructure investment and rate of interest are significant determinants of private corporate investment. Our results counter the popular belief that deficits determine interest rates in the context of emerging economies and "crowd out" private corporate investment.

Keywords: fiscal deficit; interest rate determination; asymmetric vector autoregressive model; financial crowding out (search for similar items in EconPapers)
JEL-codes: C32 E62 H6 (search for similar items in EconPapers)
Date: 2025-07
New Economics Papers: this item is included in nep-cba, nep-mon and nep-sea
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