Using high-frequency macrodata from a financially deregulated regime, the 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 interest rate determination. Using ARDL models, it is established that the interest rate is affected by inflationary expectations, not by the fiscal deficit. The term structure of interest rates in India is also incorporated into loanable fund models to analyze the transmission mechanism of the links between long-term and short-term interest rates, which is found to be affirmative, and the financial markets in India are not highly segmented. This result has significant policy implications for interest rate determination in India, especially when fiscal policy has remained accommodative for economic growth recovery through high public capital expenditure investment.

 

Key words: fiscal deficit, interest rate determination, asymmetric vector autoregressive model, financial crowding out

 

JEL codes: E62, C32, H6