Is government borrowing crowding out long term debt resources

Abstract

The study aims to empirically investigate the possibility of financial crowding out in the long term debt market in India taking the corporate bond market as a proxy. The study follows a two pronged approach. First, it tests the corporate bond market sensitivity to interest rate, along with other determinants like commercial bank credit and government securities size using the Autoregressive Distributed Lag (ARDL) approach. These are considered instrumental in the development of a long term debt market. Second, it tests if the interest rate changes are fiscal deficit induced using Granger causality framework. It finds evidence of both the interest rate sensitivity of the corporate bond market as well as the interest rates to be fiscal deficit induced, thereby empirically validating the possibility of financial crowding out in the Indian debt market segment. Based on the results, it seems that any deviation from the path of fiscal prudence can prove dear in the development of the corporate bond market. Also, the banking sector is overexposed to the risks it is not geared to handle, given by the serious asset-liability mismatches and contraction it leads in the market debt, like the corporate bond market.The government securities market could be further developed, which would provide a cue to corporate segment further and also a benchmark yield curve. The study adds to the very limited literature on the corporate bond market in India, especially in the empirical domain and possibly is the first attempt to empirically explore the aspect of financial crowding out with reference to corporate bond market.