Objectives: The study is to examine the relationship between fiscal deficit and inflation in India for the period of 1981 to 2017 with the variables such as fiscal deficit, inflation, GDP, imports, money supply, capital inflow, exchange rate & interest rate and also is to find out the debt trap of the government.
Methods/Statistical analysis: It is important to check the stationarity of the time series variable; otherwise we will get spurious results with non-stationary data. Thus, this study employs ADF test to check stationarity of the variables. It’s an advanced technique to avoid the heteroscedasticity. This study is used VAR model to find the relationship between the fiscal deficit& inflation in India and also use Granger-causality & Johansen-co-integration test to find out causal & long term relationship between the variables. A part from that, table &figure is used to show the debt trap of the government.
Findings: The ADF test result has found that inflation is stationary at level and all other macroeconomics variables are stationary at the first difference. That means all variables are not only depend on lag of others variables, but also depend on their own lags. In VAR model, there are positive significant impacts on inflation from all variables at 1 % level of significance except the exchange rate which is significantly reduces inflation by 0.89 % at 1 % level of significance. In case of import, this study has found significant inverse relation with inflation. Granger causality test show that there is bidirectional causal relationship between the variables and Johansen co-integration test show there is long run association of the variables. After the global financial crisis 2008, the fiscal deficit and interest payment are increased as an upward trend alarming to debt trap of the government, where the government borrow for the sake of repayment.
Applications: There need of coordination between the RBI and government to reduction the inflation. This study has also suggested to government to reduce fiscal deficit, so as to stay away from the debt trap.