What's New

Shedding more lights on the debt dilemma.

Current Situation:

 The elevated levels of India’s fiscal deficit and public debt have been a matter of concern for a long time in India. Even before the COVID-19 pandemic, debt levels were among the highest in the developing world and emerging market economies. The pandemic pushed the envelope further and relative to GDP, the fiscal deficit in 2020-21 increased to 13.3% and the aggregate public debt to 89.6%. As the economy recovered after the pandemic, the deficit and debt ratios have receded to 8.9% and 85.7%, respectively.

Financial repression: 

• The debt-dynamics equation states that when there is no primary deficit, if the growth rate of GDP exceeds the effective interest rate paid on government bonds, the overall debt will decline. However, what is missed in these discussions are the distortions caused by financial repression to keep the interest rates on government borrowing low to reduce the cost.
• The statutory liquidity ratio (SLR) stipulated by the Reserve Bank of India (RBI) requires the banking system to hold 18% of their demand and time liabilities in government securities. Besides, the RBI intervenes in the market through open market operations around the time when government borrowing is taken up to keep the interest rates on government borrowing repressed.
• When the interest rate on government debt is lower than the growth of GDP, the debt may decline but the financial market gets distorted. Thus, even when the sustainability of debt may not be threatened in the medium term, the costs of carrying high deficits and debt to the economy are heavy.
• First, on average, interest payments constitute over 5% of GDP and 25% of the revenue receipts, this is more than the government expenditure on education and health care put together.
• Second, high levels of debt make it difficult to calibrate counter-cyclical fiscal policy and constrain the ability of the government to respond to shocks.
• Third, the debt market in India is largely captive with mainly the commercial banks and insurance companies participating in it to meet SLR requirements.
• Furthermore, the rating agencies keep the sovereign rating low when deficits and debt are higher, and this increases the cost of external commercial borrowing.
• Finally, ‘today’s borrowing is taxing tomorrow’ and the burden of large deficits and debt will have to be borne by the next generation.

On the debt burden:

• It is clear that in the present fiscal environment, even achieving a consolidated debt-to-GDP ratio of 58.2 recommended by the 14th Finance Commission for 2019-20 would be unfeasible in the medium term.
• The Finance Commission had recommended that the Union government bring down its deficit relative to GDP from 43.6% in 2015-16 to 36.3%, and the States maintain their deficit at about 22%.
• The issue is of critical importance; therefore, the fast pacing of fiscal consolidation is imperative. Fortunately, after six years, Goods and Services Tax (GST) has stabilized and has shown high growth potential.
• The technology has helped to improve tax administration and improved compliance. With the cross-matching of GST returns with income-tax returns, income-tax compliance too is expected to improve.

Role of state and center:

• In terms of policy interventions, this is the time to rethink the role of the state and vacate activities that should really belong to the market rather than competing with it.
• At the central level, even after much talk about disinvestment, progress has been slow.
• Equally disturbing are the employment melas to fill so-called vacant posts which have been found to be redundant.
• At the State level, it is important to guard against the return to the old pension scheme and indulge in large-scale giveaways for electoral reasons.
• Of course, redistribution is a legitimate government activity, and that is best done through cash transfers rather than subsidizing commodities and services.
• Giving subsidies alters relative prices, resulting in unintended resource distortions.
• Equally important is the need to impose hard budget constraints by enforcing Fiscal Responsibility and Budget Management rules in allowing States to borrow.

Way forward:

Macroeconomic stabilization is predominantly a Union government responsibility. Therefore, the Union government should follow the rules it makes, and enforce the rules on the States effectively.