Challenges of high debt-GDP ratios

Source: The post challengesof high debt-GDP ratios has been created, based on the article “Stick to fiscal deficit as the norm for fiscal prudence” published in “The Hindu” on 7th August 2024

UPSC Syllabus Topic: GS paper3- Economy-mobilisation of resources

Context: The article discusses how high government fiscal deficits can lead to large debt burdens, impacting economic stability. It highlights India’s current fiscal challenges and the need for stricter deficit limits to avoid long-term fiscal imprudence and ensure sustainable economic growth.

For detailed information on India’s debt burden read this article here

What is the Current Fiscal Situation in India?

1. The fiscal deficit for 2024-25 is projected at 4.9% of GDP, targeted to reduce to 4.5% in 2025-26.
2. The government debt-GDP ratio is estimated at 54% by 2025-26.
3. Interest payments take up a significant portion of government revenue, with 38.4% of revenue spent on interest from 2021-22 to 2023-24.
4. Household financial savings have dropped to 5.3% of GDP in 2022-23, compared to 7.6% in the previous four years.

What challenges arise from high debt-GDP ratios?

1. Increased Interest Payments: A high debt-GDP ratio leads to rising interest payments. From 2021-22 to 2023-24, India’s central government’s interest payments averaged 38.4% of its revenue after tax devolution and grants.
2. Limited Resources for Development: As more revenue is spent on interest, less is available for developmental expenses. This hampers essential government spending.
3. Crowding Out Private Investment: A high government deficit leaves a limited investible surplus for the private sector. In 2022-23, household financial savings fell to 5.3% of GDP, fully absorbed by the government’s 7.5% fiscal deficit.
4. International Comparisons: Countries like Japan and the USA manage higher debt-GDP ratios but have lower interest payments to revenue ratios. Japan’s interest payments were just 5.5%, compared to India’s 49% during 2015-2019.
5. Asymmetric Debt Adjustment: Post-COVID, India’s debt-GDP ratio rose sharply but has been slow to return to pre-pandemic levels.

What Should be Done?

1. India needs a clear roadmap to reduce its fiscal deficit to 3% of GDP to manage its debt more effectively and free up resources for private investment.
2. This approach is crucial, especially given the lower household savings rate of 5.3% of GDP in 2022-23, compared to 7.6% before the COVID-19 pandemic.
3. Sticking to a stricter fiscal deficit limit would help stabilize the economy and foster healthier investment levels.
4. The Twelfth Finance Commission suggested balancing household savings and foreign capital to support a 6% fiscal deficit, but current deficits exceed this, limiting private investment opportunities.

Question for practice:

Examine how India’s high fiscal deficit and debt-GDP ratio impact private investment and economic stability.