India Should Worry About its Public Debt

Context: India must be worried about the economic repercussions from a debt overhang that a large fiscal stimulus will entail post-covid-19 economic recovery.

Trends of Rising Public Debt in India

• Till 1972 – Rise in general debt for the Centre and state: to about 39% of Gross Domestic Product (GDP)In 1974 - fell sharply Explosive growth after 1996: reached 57% in 2005 and in 2018 approximately 57% of GDP. (Chart 1)

Arguments favouring the Budget move of raising public debt:

• Pandemic induced low-interest rates: 
  • Lower interest rates mean countries are less constrained by fiscal space. 
  • Large fiscal expansions can thus improve fiscal sustainability by raising GDP more than they raise debt and interest payments.
  • E.g. despite a ballooning US federal debt/ GDP ratio from below 50% in 2000 to about 100% in 2020, federal interest payments in the US is only about 1-2% of GDP.
  • This has led to the birth of New Fiscal Consensus: the notion that in a world of low-interest rates, advanced economies can run limited primary deficits and have stable public debt.

Key Components that Altered Public Debt in India (between 1951-2018): 

• Inflation: Inflation is the dominant component in reducing India’s public debt. 
  • Although the inflation component has begun to diminish after the adoption of flexible inflation targeting (FIT) in India in 2014.
  • Negative implication of inflation-induced debt liquidation:
    • Negative co-movement between the inflation component and REER.
    • Increased volatility and uncertainty in inflation based liquidation due impact on Household savings and REER
• Interest rate: Out of the 5% increase in India’s public debt between 2008 and 2018, around 12% is the due nominal interest rate.
  • Since 2006, the interest rate component, helped by enacting the Fiscal Responsibility and Budgetary Management Act, exhibits a marked decline.
  • For all outstanding central and state securities, the weighted average nominal return continues to be high and has averaged around 7% around 5% in the last five years. 
• Real GDP growth: debt can be liquidated by high real GDP growth, (as it did between 2003-08). There is a positive co-movement of growth with the following
  • Real Effective Exchange Rate (REER)
  • Households savings
  • Debt liquidation by growth tends to bring down uncertainty, debt liquidation via inflation led to more uncertainty in the economy.

Economic repercussions from high debt: it alters interactions between monetary, fiscal and debt management policy

• Raises spectre of fiscal dominance: since 1951, the sustainability of Indian public debt has been helped by debt liquidation in an environment of fiscal dominance.
• Interest rate continues to remain elevated despite trending down (recent interest payments/GDP ratio has averaged about 1% of GDP).
• Raises debt servicing cost: public health and education allocations which are already abysmally low suffer due to rising debt-servicing costs.