India must reduce its public debt ratio to build economic resilience

Source– The post is based on the article “India must reduce its public debt ratio to build economic resilience” published in the mint on 8th February 2023.

Syllabus: GS3- Government budgeting

Relevance– Issues related to public debt and government borrowing

News– The new budget has a credible plan to reduce the fiscal deficit as a proportion of India GDP.

What are the implications of high public debt ratio for macroeconomic policy over the medium term?

Interest cost of servicing this public debt reduces the capacity of the government to spend on essential things like infrastructure, welfarism and defence.

It reduces the capacity of the government in responding to future shocks.

RBI ability to conduct independent monetary policy to control inflation is impacted.

How can public debt be managed?

Any strategy to reduce public debt needs to be built on three pillars–

There must be acceleration in nominal GDP growth.

Acceleration in nominal GDP growth should be seen in context of the cost of government borrowings.

The focus of fiscal policy must be to reduce not only the headline deficit but also the primary deficit.

The experience of previous decades provides us with useful context. Public debt came down by 17% between 2002 and 2011. This period can be broken down into two.

The first part of success was because of the high growth rate. It led to a sharp fall in primary deficit. In the second part, nominal GDP grew at a fast pace despite the global financial crisis. This was possible by high inflation.

What is the future scenario of public debt for the Indian economy?

Trajectory of public debt will depend on growth in economic output, inflation, interest rate and fiscal policy.

Nominal GDP in coming years is likely to be in very low double digits, unless there is structural shift in potential growth and inflation. The gap between nominal GDP and inflation will be low.

So, the automatic drivers bringing down public debt will not work. Government will have to use fiscal policy to bring down the primary deficit.