India’s debt burden- Explained Pointwise

The International Monetary Fund (IMF) recently raised long-term sustainability concerns about India’s debt burden. 

It states that India’s government debt could be 100% of GDP under adverse circumstances by fiscal 2028. According to the IMF, “Long-term risks are high because considerable investment is required to reach India’s climate change mitigation targets and improve resilience to climate stresses and natural disasters. This suggests that new and preferably concessional sources of financing are needed, as well as greater private sector investment and carbon pricing or equivalent mechanism.” 

In light of this, it is important to take a detailed look at India’s Debt Burden.

What is Public Debt, and what is the status of India’s Debt Burden?

Public Debt- Public debt refers to the amounts owed by the different levels of government and used to finance public deficits resulting from a higher level of program spending to budgeted income. Debt can be acquired within the same country or abroad and usually takes the form of bonds, paper and government securities

Status of India’s debt- The Union government’s debt was ₹155.6 trillion, or 57.1% of GDP, at the end of March 2023 and the debt of State governments was about 28% of GDP.
As stated by the Finance Ministry, India’s public debt-to-GDP ratio has barely increased from 81% in 2005-06 to 84% in 2021-22, and is back to 81% in 2022-23.
This, however, is way higher than the levels specified by the Fiscal Responsibility and Budget Management Act (FRBMA). The 2018 amendment to the Union government’s FRBMA specified debt-GDP targets for the Centre, States and their combined accounts at 40%, 20% and 60%, respectively.

Why do governments need to take public debt?

Governments borrow money for several reasons:

1. Budgetary Needs- Sometimes, a government might spend more money than it earns in revenue through taxes. This budget deficit can occur due to various reasons like infrastructure projects, social welfare programs, defence spending, etc. Borrowing allows governments to cover these deficits without cutting essential services or raising taxes immediately.

2. Smooth Economic Cycles- During economic downturns or recessions, governments might stimulate the economy by increasing spending. Borrowing allows them to inject money into the economy to create jobs, boost demand, and support businesses.

3. Capital Expenditure- Governments often invest in long-term projects like building roads, bridges, schools, and hospitals. Borrowing funds these projects upfront, and the cost is spread over many years, aligning with the benefits these projects bring over their lifetime.

4. Cash Flow Management- Governments might borrow to manage short-term cash flow mismatches. They might have incoming revenue delayed, but need immediate funds to cover ongoing expenses.

Governments usually issue bonds to borrow money, promising to repay the borrowed amount with interest over a specified period. These borrowings are often a fundamental part of fiscal policy, allowing governments to manage their economies and provide essential services.

What are the advantages of borrowing by the governments?

1. Funding Infrastructure- Borrowing allows governments to fund large-scale infrastructure projects that have long-term benefits for society, such as building roads, bridges, airports, and utilities. These projects often stimulate economic growth and productivity.

2. Investment in Social Programs- Governments borrow to invest in social programs like education, healthcare, and welfare to improve the quality of life for their citizens.
For instance, due to sustained demand for employment under MGNREGA, a sum of ₹79,770 crore has already been spent till December 19, 2023, as against the budgeted ₹60,000 crore and an additional sum of ₹14,520 crore has been allocated.

3. Economic Stimulus- During economic downturns, borrowing funds for stimulus packages can help jumpstart the economy by increasing consumer spending, supporting businesses, and reducing unemployment.

4. Interest Earnings- If governments can borrow at low-interest rates, they can invest borrowed funds in projects or initiatives that generate higher returns, potentially boosting economic growth.

5. Spreading Costs Across Generations- Some experts argue that borrowing allows current generations to share the cost of infrastructure and services with future generations that will also benefit from these investments.

6. Debt Refinancing- Governments also borrow to refinance existing debt. This involves replacing old debt with new debt that has better terms or lower interest rates, reducing the overall cost of debt servicing.

What are the issues with a large debt burden?

A large debt burden for a government can lead to various issues such as:

1. Higher Debt Servicing Costs- As the debt increases, so do the interest payments on that debt. A significant portion of government revenue might then be allocated to paying interest on the debt, reducing the funds available for essential public services and investments.

2. Reduced Fiscal Flexibility- High debt levels can limit a government’s ability to respond to economic downturns or emergencies. It constrains fiscal policy options, as a substantial portion of the budget might already be committed to servicing the debt, limiting the ability to spend on critical needs or implement stimulus measures.

3. Increased Risk of Default- If debt levels become unsustainable and the government struggles to make interest payments or refinance debt, it can lead to a risk of default. Defaulting on debt can have severe consequences, including a loss of investor confidence, higher borrowing costs in the future, and economic turmoil.

4. Crowding Out Investment- High government borrowing can lead to increased competition for available funds. This can crowd out private investment as the government absorbs a significant portion of available capital, potentially slowing down economic growth and private sector development.

5. Pressure on Future Generations- Excessive debt burdens can pass on economic challenges to future generations. They might inherit a weaker economy, higher taxes, reduced public services, and limited opportunities due to the need to allocate substantial resources to debt repayment.

6. Credit Rating Downgrades- Persistently high levels of debt relative to GDP can lead credit rating agencies to downgrade a country’s creditworthiness. A lower credit rating makes borrowing more expensive and can further exacerbate debt problems.
For instance, Fitch Ratings and S&P Global Ratings have kept India’s credit rating unchanged at ‘BBB- with stable outlook’ since August 2006 (BBB- is the lowest investment grade rating). These agencies believe that India’s stronger fundamentals are undermined by the government’s burdensome debt stock.

7. Currency and Inflation Risks- In extreme cases, high government debt can lead to currency devaluation or inflation if the government decides to monetize the debt by printing more money. This can erode the value of savings and create instability in the economy.

What should be the way forward?

Managing public debt burdens requires a combination of prudent fiscal policies, responsible borrowing practices, and strategic debt management. These are some steps that the Indian government can follow:

1. Fiscal Discipline- Governments should aim for balanced budgets or surpluses during economic expansions to create buffers for potential downturns. This involves controlling spending, increasing revenue through fair taxation, and avoiding excessive borrowing for non-essential expenditures.

2. Debt Management Strategies- Implement effective debt management strategies to minimize borrowing costs and risks. This includes refinancing existing debt at favorable rates, considering fixed vs. variable interest rates, and optimizing the debt maturity structure.

3. Transparent and Credible Fiscal Policies- Clear communication and transparency regarding fiscal policies, debt levels, and strategies for managing debt are essential. This helps build confidence among investors, citizens, and international markets.

4. Prioritize Investments- Governments should prioritize borrowing for productive investments that yield long-term economic benefits, such as infrastructure, education, and healthcare, rather than for recurrent expenses or inefficient projects.

5. Diversify Funding Sources- Governments can diversify their sources of funding to mitigate risks. Instead of relying heavily on short-term debt or foreign currency-denominated debt, they can consider longer-term financing or domestic borrowing.

6. Sustainable Economic Growth Policies- Encouraging policies that foster sustainable economic growth can expand the tax base, increase revenue, and reduce the relative size of the debt burden.

By implementing these measures, the government can strike a balance between meeting their financing needs for development and infrastructure while ensuring that public debt remains at sustainable levels to safeguard the economy and future generations from excessive debt burdens.