Introduction One of the important features of most of the developing economies during the early stages of development was

the increased reliance on public debt to finance not only public investment but also to meet the growing expenditure. India also experienced a similar pattern of development since its independence in 1947, Indian government continuously witnessed excess of expenditure over its sources of revenue. This excess expenditure or the deficit was financed mainly by the increased borrowings from both within and outside the country. The rising trend in securing financial resources through public borrowings has specially been steep since the early 1980s (Singh, 1999). Persistent and high public debt calls for a large amount of budgetary allocation for debt servicing. Consequently, the government was forced to cut allocations for other public services (Krugman, 1988; Savvides 1992; Agenor and Montiel, 1996; Serven, 1997 and Moss and others 2006). Role and Significance of Public Debt At the same time, public debt has its own positive effects on the economy as well. It is a well known fact the debt supplements the capital needs of the economy. Increasing public expenditure induces the demand thereby expands market for the products. Therefore, as long as the borrowed money is spent productively, the effects of debt on the economy are favorable and will increase the welfare of the society. In the negative sense, public debt leads to interest burden which may absorb significant government revenues and thereby crowd-out pro-poor and growth enhancing spending. Review of Literature There are number of studies both at the national and international levels on the effects of public debt. Chowdhry (1994) investigated the direct, indirect and full effects of external debt on GNP and vice versa for the period 1970-1988 on selected countries in Asia and the Pacific, namely Bangladesh, Sri Lanka and Thailand. The results of the public and private external debt on the GNP level in these countries was small and heavy debt burden prevented countries from investing in their productive capacity, investment necessary to spur economic growth. Puspha kumari (1996) studied the growth of external debt of developing countries and found the growth of external debt in developing countries as rapid mainly due to import of capital goods and use of external borrowings for financing the current account deficits. The study further found that the debt inflows did not positively contribute to economic growth. Basu and Datta (2005) examined the impact of the fiscal deficit on Indias external accounts since the mid-1980s and found an absence of cointegration between the trade deficit and fiscal deficits. Further, it was pointed out that the absence of cointegration between the savings rate and the fiscal deficit, and GDP ratio negates the Ricardian Equivalence Hypothesis (REH) in Indian circumstances. Rangarajan and Srivastava (2005) have analysed the relative contribution of cumulated primary deficits and the cumulated effects of the excess of growth rate over interest rate on the accumulating outstanding liabilities. The implications of the sign reversal in the difference between real growth and interest rates were highlighted. The study noted that most of the intra-year variability in the process of debt accumulation was due to the volatility of the nominal growth rates. The position of state government would be even more difficult as the effective interest rate was higher in their case.

Panchamukhi (2001) highlighted Indias significant external debt position. The share of commercial debt as a percentage of total debt declined consistently over the period 1990-1999 (from 46.7 % in 1990 to 37.9 % in 1999). Similarly the debt servicing ratio also came down. However, the issues of concern pertain to the high degree of volatility in the debt and the persistence of a high debt stock to GDP ratio and a rather high debt service ratio. Bhattacharya and Guha (1992) analysed the causes of the rising domestic and external debt of India during the period 1975 76 to 1988 89. The findings shown that the hike in the interest rate structure was a major cause of the rise in debt / GDP ratio in the 80s and debt and growth were interdependent through government budget constraint and public investment behavior. Mohan (2000) analysed that data on state and central government revenue and expenditure to suggest ways to climb out of the debt trap. It was noted that debt service payments continuously rose as a proportion of total revenue over the last two decades. That is debt service payments of the central government have raised inexorably from about 30 % of tax revenues in 1980 - 85 to about 70 % in 1999-2000. Researchable Issues Public borrowing has its own positive and negative impact on the economy. An in depth analysis of the public debt raises the following issues: i) Does the inadequate debt management and a permanent growth of debt to Gross Domestic Product ratio result in negative economic growth? ii) Is it true that external borrowing is ought to accelerate economic growth especially when domestic financial resources are inadequate and need to be supplemented with funds from abroad? iii) Economic theory also postulates that reasonable levels of borrowing promote economic growth through factor accumulation and productivity growth. Can it be so? iv) It is often argued that if the borrowing countries channel the borrowed funds into productive investments and they enjoy macroeconomic stability, they will be able not only to accelerate their economic growth but also to settle their debt obligations comfortably. Does it hold good for developing countries? v) The government of India implemented economic reforms in 1991 to speed up the inflow of non-debt oriented foreign capital to support the growth of the economy. Is there any positive effect of economic reforms on the level of public debt in India? Statement of the Problem Growing public debt is a general phenomenon and it has become a common feature of the fiscal sectors of most of the economies. According to the earlier literature on public debt, there are controversial arguments on the effects of public debt on the economic growth. Further, when governments borrow domestically, they use up domestic private savings that would otherwise have been available for private sector lending. In turn, the smaller amount of loanable funds available in the market raises the cost of capital for private borrowers, reducing private investment demand, and hence capital accumulation, growth and welfare. Nevertheless, economic theory also postulates that reasonable levels of borrowing promote economic growth through factor accumulation and productivity growth. This is because the countries at the initial stages of their development usually tend to have smaller capital

stocks and their investment opportunities are limited, which promise high rates of returns in them. However, in practice, the accumulation of internal as well as external debt can dampen growth by hampering investment and productivity growth. Understanding the harmful effects of public borrowing, specifically external borrowing, the government of India implemented a set of structural programmes almost in all the spheres of the economy in 1991 to speed up the inflow of non-debt oriented foreign capital to support the growth of the economy. The higher inflow of capital would normally reduce the dependence of the borrowing. This calls for an in depth examination to estimate the impact of economic reforms on the growth of public borrowing in the country. In view of the changed environment, the study identifies the dominant factors which were responsible for the changes in the growth of debt during the pre and post-reform period which has become an important issue in recent times. Objectivies i) To study the growth of internal and external debt in the country during the pre and post-reform period and the changes in the composition of the internal and external debt of the country ii) To find out the major determinants of internal and external debt iii) To examine the nature and direction of causation between debt and economic growth Hypotheses The study has formulated the following testable hypotheses i. There is no relationship between Economic reforms and the growth of debt. ii. There is no differential influence of Economic reforms on internal and external debt. iii. There is no causation running from debt to economic growth Methodology i) Sources of Data The secondary data collected from the official reports of Reserve Bank of India, Ministry of Finance and Central Statistical Organisation for the period 1980-81 to 2007-08 formed the source of data. ii) Period of Study The total period of 28 years (from 1980-81 to 2007-08) was divided into two subperiods namely, the Pre-Reform (1980-81 to 1991-92) period and Post-Reform period (1992-93 to 2007-08). Panagariya (2004) and Ahluwalia (2002) considered the post-reform period beginning from 1992-93 whereas Balakrishnan (2005) considered from 1990-91 onwards. While there are controversial arguments in the classification of the above said time period into pre and post-reform, the study considered the period of post-reform as commencing from 1992-93. iii) Method of Data Analysis The study used the basic statistical tools like mean, coefficient of variation, simple and compound growth rates. The study also applied the semi-log quadratic equation of the following form to estimate the growth acceleration/deceleration in the debt over the period of study. lnY = a + bt + ct2+u In order to find out the role of economic reforms on the growth of public debt, the study applied Chow test and dummy variable approach to determine the impact of reforms

on the growth of public debt of the country. Multiple regression models were fitted to identify the major factors responsible for the growth of public debt, both internal and external, in the country. Regression Model for the Internal Debt lnY= + 1 lnX1 + 2 lnX2 + 3 lnX3+ 4 lnX4+ 5 lnX5+ where, Y = Internal Debt (ID),X1 = Primary Deficit (PD) X2 = Gross Domestic Product (GDP) X3 = Population (POP) X4 = Interest Payments (INT) X5 = Inflation (WPI) = stochastic disturbance term (, the intercept, s, the coefficients and ln is the natural logarithm) Regression Model for the External Debt lnY= + 1 lnX1 + 2 lnX2 + 3 lnX3+ 4 lnX4+ 5 lnX5+ where, Y = External Debt (ED) X1 = Gross Domestic Product (GDP) X2 = Debt Servicing (DS) X3 = Trade Openness (TO) X4 = Trade Deficit (TD) X5 = Foreign Exchange Reserves (FER) = stochastic disturbance term (, the intercept, s, the coefficients and ln is the natural logarithm) All these exercises were carried out separately for the pre and post-reform period to throw more light on the role of ongoing economic reforms in the country. Further to analyse the interrelationship between the debt and economic growth, Cointegration and Vector Error Correction Model (VECM) were employed. Prior to the application of the model, the stationarity of the variables was tested by applying Augmented Dickey Fuller (ADF) Test of the following form;

: Xt = 1 + 1 t + Xt-1+ i 1 Xt-1 + t Finally, Granger test of causation of the following form was applied to under stand the direction of causation between debt and economic growth. lnDebtt = + 1 lnGDPt-1 + 2 lnDebtt-1 + 3Zt-1 + lnGDPt = + 1 lnDebtt-1 + 2 lnGDPt-1 + 3Zt-1 + These tests were applied separately for the internal and external debt and economic growth in the country during period under study. Major findings of the Study The internal debt occupied a greater share in the total debt and was found increasing during the study period as against the external debt which was noticed to be declining. Thus the government of India changed the pattern of financing the deficit from external debt to internal debt. The steady and continuous decline in the external debt was due to the greater inflow of non-debt oriented nature of foreign capital to supplement the capital needs of the country. During the pre-reform period, the growth of short term external debt was higher than the long term external debt. The share of short term and long term debt in the total external debt were found fluctuating during the pre-reform period but the trend was noticed to be increasing in the case of short term debt and declining in the case of long term debt. During the post-reform period, there was a clear indication of slow growth of long term debt where as the growth of short term debt was higher. A simple comparison of the regression equation of the determinants of internal debt for the pre and post-reform periods revealed two significant differences in the estimated coefficients. Firstly, no factor was found significant in the pre-reform period, where as in the post-reform period the variables GDP and population were found statistically

significant. Secondly, there was expected change in the signs of the coefficients in primary deficit (PD), GDP and inflation (WPI) which were not so in the pre-reform period. In the case of external debt, from the estimated regression equation, it was found that only variables GDP and debt servicing (DS) were significant in the pre-reform period where as during the post-reform period all the variables were found as statistically significant in determining the external debt except trade openness (TO). The direction of causation between debt and economic growth (which was estimated by using test of Granger Causation) was found that the Granger causality runs from internal debt to economic growth. The significant value of F test at 5 per cent level also justified this inference for the one way causation. Similarly, there was one way positive causation running from economic growth to external debt in India during the period of study. Chapter Scheme The proposed study will unfold in the following way Chapter-I: The introduction and the definition of the components of public debt. Statement of the problem, objectives and methodology were described in this chapter. Chapter-II: A brief review of earlier studies on public debt with appropriate classification. Chapter-III: The trends in the growth of public debt and changes in the components of debt in the country. Chapter-IV: The major determinants of internal and external debt. Chapter-V: The nature and direction of causation between debt and economic growth. Chapter-VI: Major findings of the study. Chapter-VII: Issues and policy suggestions.

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