Working Paper No. 1023 Climate Change and Fiscal Marksmanship: Evidence From an Emerging Country, India by Lekha Chakraborty Levy Economics and International Institute of Public Finance, Munich Ajay Narayan Jha (Former) Government of India and Finance Commission Jitesh Yadav and Balamuraly B (Former) National Institute of Public Finance and Policy (NIPFP) and Amandeep Kaur National Institute of Public Finance and Policy (NIPFP) July 2023 This paper is an abridged version of the paper invited for International Institute of Public Finance (IIPF) Meetings in Utah State University, August 14–16, 2023. Thanks are due to Professor Pinaki Chakraborty (Asian Development Bank) for his valuable comments. The Levy Economics Institute Working Paper Collection presents research in progress by Levy Institute scholars and conference participants. The purpose of the series is to disseminate ideas to and elicit comments from academics and professionals. Levy Economics Institute of Bard College, founded in 1986, is a nonprofit, nonpartisan, independently funded research organization devoted to public service. Through scholarship and economic research, it generates viable, effective public policy responses to important economic problems that profoundly affect the quality of life in the United States and abroad. Levy Economics Institute P.O. Box 5000 Annandale-on-Hudson, NY 12504-5000 http://www.levyinstitute.org Copyright © Levy Economics Institute 2023 All rights reserved ISSN 1547-366X ABSTRACT According to the theory of efficient markets, economic agents use all available information to form rational expectations. The rational expectations hypothesis asserts that information is scarce, the economic system generally does not waste information, and that expectations depend specifically on the structure of the entire system. Fiscal marksmanship—the accuracy of budgetary forecasting—can be one important piece of such information that rational agents must consider in forming expectations. Against the backdrop of fiscal rules, our paper explores the budgetary forecast errors of climate change–related public spending in India. The fiscal rules stipulate that fiscal deficit–to–GDP ratio should be maintained at 3 percent. However, in the post-COVID fiscal strategy, a medium-term fiscal consolidation path of 4.5 percent fiscal deficit–to–GDP is envisioned by 2025–26. Within this fiscal consolidation framework, we analyzed the budget credibility of fiscal commitments for climate change in India. We analyzed the fiscal behavioral variables in terms of bias, variation, and randomness, and captured the systemic variations in budgetary forecast related to climate change for a period 2017–18 to 2020–21 across sectors. We identified the sectors where systematic components of forecasting errors are relatively higher than random components, where minimizing errors through altering the fiscal behavioral models is done by revising the assumptions and by applying better forecasting methods. A state-level decomposition of the public spending revealed that disaggregated fiscal space available for developmental spending constitutes around 60 percent of the total. However, identifying the specifically targeted public spending related to climate change across all states and analyzing its fiscal markmanship can further the subnational inferences. KEYWORDS: Fiscal Marksmanship, Budget Forecast Errors, Climate Change, State Finances JEL CODES: H30, H50, H70, Q58 1 1. INTRODUCTION According to the theory of efficient markets, economic agents use all available information to form rational expectations. The rational expectations hypothesis asserts that information is scarce, the economic system generally does not waste information, and that expectations depend specifically on the structure of the entire system. Fiscal marksmanship—the accuracy of budgetary forecasting—can be one important piece that rational agents must consider in forming expectations. The significant variations between actual revenue and expenditure from the forecasted budgetary magnitudes could be an indication of fiscal policy objectives not being optimized or attained. In this context, the role of budget estimates needs to be emphasized as a fiscal signal. This point has gained much momentum especially when expectations are based, not on what has happened in the past, but on the data relating to the future. That is, if expectations are rational rather than adaptive, it is the estimate