What does rising public debt mean for the economy 

What is the news? 

Covid-19 pandemic has resulted in a wider fiscal deficit and higher public debt-to-GDP (gross domestic product) ratio. A higher debt to GDP ratio has many consequences for the economy, apart from this the composition or quality of debt also matters. 

What does public debt- to-GDP ratio mean? 

Public debt-to-GDP ratio is the ratio of what a country owes to what it produces—a measure of the financial leverage of an economy.  

Public debt consists of external debt (which has been borrowed from foreign lenders) and internal debt (like government securities, treasury bills, short-term borrowings).  

How does it reflect the stability of the economy? 

A country which is able to continue paying the interest on its debt i.e. without hampering economic growth and refinancing is considered to be stable.  

According to the recommendations of the N.K. Singh Committee (2016), debt- to-GDP ratio should have been 38.7% for the Centre and 20% for states by 2022-23 (FY23).  

What are current statistics for the debt to GDP ratio? 

The Centre’s debt-to-GDP ratio for FY22 was 59.9%, while budget estimates for FY23 have pegged it at 60.2%. 

How does high debt affect the economy? 

Increasing public debt results in a rise in interest payments burden. This deprives the government of its ability to undertake development and welfare measures.  

Increased public debt could also impact the outlook of rating agencies. 

Inflationary crisis: Widening fiscal deficit creates pressure on market interest rate with the government being a major player. This impacts private firms, thereby increasing per unit cost that is passed on to consumers. This is cost-push inflation. 

Why does the quality of debt also matters? 

The quality of debt is also crucial—i.e. whether it is meant for meeting capital expenditure or revenue expenditure. Capital expenditure supports the developmental process and aids economic growth in the medium to long term.

Revenue expenditure is at the cost of future prospects. 

How then to control public debt? 

 Fiscal Responsibility and Budget Management Act (2003) mandated the government to limit its fiscal deficit to 3% of GDP. That helped in improving interest payment burden, leaving more fiscal space for developmental as well as welfare measures. However, the pandemic led to increased government borrowings. 

Public mindset about freebies needs to change, as what is spent by the government is eventually borne by the taxpayer. 

Source: This post is based on the article “What does rising public debt mean for the economy” published in Live Mint on 14th Feb 2022.