India will face the toughest challenge of public debt in the 2020s

The International Monetary Fund estimated in January that governments around the world had collectively spent tr 14 trillion to mitigate the economic impact of the epidemic. The size of the global economy in 2019 is tr 88 trillion. This additional spending, combined with the fall in tax revenues, led to a huge increase in the fiscal deficit. Central banks have also stepped in by unleashing a liquidity wave. Regulators have adjusted regulations to prevent banks from falling to their knees through bankruptcy waves. Some governments have given credit guarantees to small companies.

This is not the time for premature ejaculation, as the second wave of Kovid infections in India makes it clear that the war against the virus is still ongoing. However, the risk of long-term financial stress cannot be ruled out. Finance Minister Nirmala Sitharaman has indicated in her budget speech that economic policy will be expanding till the end of 2025-26. The annual economic trajectory is important, but the anchor of monetary policy is to stabilize the ratio of government debt to gross domestic product (GDP). That said, the current decade promises to be challenging.

Public debt is likely to remain high, although annual financial figures are improving with the economic recovery. The interest costs of high public debt depend on the government economy. The 15th Finance Commission has reported that the consolidated public debt / GDP ratio of the central government and the states will be 85.7% by the end of 2025-26, down slightly from the current 89.8%. This is the highest in many decades, and is 25 per cent higher than the target set by the Committee to Review the Financial Responsibility and Budget Management (FRBM) Framework in 2023. India is thus in unfamiliar economic waters.

Much of the debate on the stability of Indian public debt revolves around two key variables — the economic growth rate and the interest rate at which the government borrows from the market. India should not worry too much about debt as long as the government borrows at an interest rate lower than the economic growth rate. The logic is flawless, but loses a third debt variable, which is also important in the analysis of government debt stability — the annual financial balance after the primary deficit or interest payments are ignored.

The more authentic approach to the stability of Indian public debt is as follows. The government can maintain the primary deficit as long as economic growth exceeds the sovereign borrowing costs. However, if sovereign borrowing costs exceed the economic growth rate, the government should ensure that it maintains a basic surplus. In fact, the government needs to figure out how to reduce the debt-to-GDP ratio of GDP to high economic growth, low interest rates and the primary deficit / surplus.

Getting out of a living problem is the most attractive option. India reduced its debt / GDP ratio by 18 percentage points from 2002-03 to 2010-11. Only two of these eight years, when nominal economic growth is high, have a primary surplus in the government budget. When interest rates are kept low by inflation control, India may emerge from its public debt challenge in the next decade as the economy picks up the old um.

A walk through history illustrates some of these issues. The UK exited World War II with a public debt / GDP ratio of over 250%. It dropped to 62% by 1971 or 25 years later. Nicholas Krafts of the University of Warwick explained this fall by 60% growth-interest rate differentiation and 40% primary budget surplus. India currently has a very modest public debt / GDP ratio and is not on the edge of the economic hill. This could reduce it by high nominal GDP growth over the next decade.

What if the recovery in economic growth is modest? Then the choices become more difficult politically. Two of them are worth mentioning here.

One, interest rates are artificially suppressed by some form of financial oppression. It is unclear how inflation targeting the central bank in an economy with capital inflows can handle such economic repression.

Two, taxes were raised in support of the government budget. Looks like the US is already moving in that direction. Over the past few years, India has cut corporate tax rates, but increased the income tax rate for those at the top of the pyramid as well as raised higher import tariffs on a variety of goods.

In June 2015, two years after the rupee had almost run out, the Indian government began reducing the fiscal deficit in an effort to stabilize the economy.

This column then commented: “Losses to financial stability have shifted from government to the business sector.” The question that needs to be asked right now is: let’s look at the mirror image in the coming years, the improvement in the private sector balance sheets about the government’s economic decline?

Niranjan Rajadhyaksha Meghnad Desai Member of the Academic Board of the Academy of Economics

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