CROWDING-IN EFFECT OF BUDGET DEFICIT EVIDENCE FROM PAKISTAN (1960-2005)

The paper critically analyzes the effect of budget deficit on private and public investment. Annual data for the period 1960-2005, taken from Economic Survey of Pakistan and International Financial Statistic is used for analysis. Simultaneous equation model is used for estimation. The study revealed that bank credit to private sector, government domestic bank borrowing, and foreign reserves have positive significant effect on money supply. Demand for money is positively related to out put and negatively to interest rate. Out put is positively related to consumption expenditure, private investment, public investment, balance of trade and negatively related to real interest rate. Private investment is positively related to out put, bank credit to private sector and negatively related to interest rate. The relationship between private investment and interest rate is statistically significant only at 10%, signifying that interest rate is not affecting private investment because of the greater return to private investors. Public investment is positively related to out put and foreign reserve and negatively to real interest rate. Both domestic bank borrowing and foreign borrowing to finance budget deficit crowded-in private and public investment with same elasticity, but foreign borrowing encourage foreign reserve outflow. Based on findings of the study it is recommended that domestic sources of financing including domestic non-bank borrowing and bank borrowing should encourage for budget deficit financing.