Economic Survey 2020-21: Vol 1 Ch 2: Does Growth Lead to Debt Sustainability? Yes, But Not Vice-Versa!

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• This Chapter establishes clearly that growth leads to debt sustainability in the Indian context but not necessarily vice-versa.
• This is because the interest rate on debt paid by the Indian government has been less than India’s growth rate by the norm, not by exception.

• Keeping in mind the stabilizing nature of the countercyclical fiscal policy, the Economic Survey prescribes that India should put a greater focus over it. In a country like India which has a large workforce employed in the informal sector, counter-cyclical fiscal policy becomes even more paramount. 
• Moreover, counter-cyclical fiscal policy becomes critical during an economic crisis. This is the result of the fact that fiscal multipliers which capture the aggregate return derived by the economy from an additional Rupee of fiscal spending are significantly greater during economic crises when compared to an economic boom.
• For example: In the ancient times, during difficult times like famines and droughts, the Indian Kings used to build palaces in order to provide employment to the suffering masses and improve the economic fortunes of the private sector. This clearly shows the importance of counter-cyclical economic policy.
• The Economic Survey states that, for India, in the current scenario, when private consumption, which contributes to 54 per cent of GDP is contracting, and investment, which contributes to around 29 per cent is uncertain, the relevance of counter-cyclical fiscal policies is paramount.

• Debt sustainability denotes that the overall debt on the government is not running out of control and is the debt is being managed with caution. This debt sustainability is primarily dependent on the ‘interest rate-growth differential (IRGD)’ which is the difference between the interest rate and the growth rate (also called the r-g differential, where ‘r’ denotes interest rate and ‘g’ denotes growth rate).

The IRGD parameter and debt sustainability in India:

• The Economic Survey states that as a norm in India, over the last two and a half decades, GDP growth rates have been greater than interest rates. During the last 25 years, Nominal Growth Rate had been greater than the Nominal Interest Rate (except a short period during the Asian Financial Crises-1997).
• This has led to a negative IRGD for most of the years during the last two and a half decades, which has consequently led to a decline in debt levels in India.
• Moreover, in India, there has been a higher variability in growth rates relative to interest rates over the past 25 years. This implies that changes in IRGD are mostly attributable to changes in growth rates rather than the changes in interest rates.
• Thus, it is a higher growth that provides the key to the sustainability of debt for India.

IRGD and debt sustainability for other economies:

• Similar to the Indian experience, economic date from IMF and World Bank show a strong correlation between IRGD and incremental debt-to-GDP ratio for other countries like Japan, Canada, China, Malaysia etc.
• The years that correspond to negative IRGD are accompanied by a steeper decline in debt levels across these countries. Cross-country evidence also shows higher variability is observed in mean growth rates across countries as compared to variability in average interest rates. 
• Thus it is important to examine the dynamics of debt sustainability for high growth economies separately from that for low growth ones.

India’s position in comparison to other countries:

• On analysing the averages of real interest rate, real growth rates and IRGD for the period 1990- 2018 across selected emerging and advanced economies, it can be seen that India – as one of the high growth economies – is amongst the countries having negative average IRGD, along with other countries such as China, Russia and Singapore.
• Also, the graph given below shows that since 2003, India’s IRGD has been negative and the lowest for the major OECD countries.

• A cross-country comparison of debt levels points out the following points for India:
• The ‘government debt level as a proportion of GDP’ is equal to the median in the group of G-20 OECD countries and in the group of BRICS nations.
• India’s ‘overall debt levels as a per cent of GDP’ are the lowest amongst the group of G-20 OECD countries and also among the group of BRICS nations.
• Public debt and overall debt level for India has declined since 2003 and has been stable since 2011.
• Share of External Debt: The government’s debt portfolio which is external in nature (i.e. borrowed from outside the country) is only 2.7 per cent of GDP (5.9 per cent of total Central Government liabilities).

Distribution of Debt Between the Centre and the States:

• Of the total public debt, 70% is held by the Centre and only 30% by the states. This distribution of debt between the Centre and the states is desirable since the central government is entrusted with the responsibility of macroeconomic management.
• India majorly issues longer tenure bonds for raising funding which ensures that there is no immediate pressure of returning the principal and paying the interest. This provides breathing space to projects and helps in generating revenue.

Nature of Rate of Debt:

• The share of floating rate debt is very low in the overall public debt. Floating debt rate of the Central government is less than 5% of public debt). This tends to limit rollover risks and insulates the debt portfolio from volatility in interest rate.

Is India’s current debt sustainable?

The Economic Survey concludes that India’s debt will remain sustainable due to the following factors:

• Since ‘crowding out’ of the private investment is not a phenomenon present in India, an increase in the general government debt-to-GDP correlates with lower (not higher) nominal interest rates.
• In the last three decades, a strong negative correlation between the debt-to-GDP ratio and nominal interest rates in India is observed.
• The 5-year forward interest rates for all maturities (1 year, 5 years, 10 years, 20 years and 30 years) have been trending down sharply over the last decade.
• The IRGD is very likely to be negative for India in a 5-year horizon, thus leading to debt sustainability as previously discussed.
• To ensure that the economy remains in good health to avail the full benefit of these significant reforms, the “economic bridge” to the medium and long-term has to be created.
• Only an active fiscal policy – one that recognises that the risks from doing too little are much more than the risks from doing too much – can ensure that this “economic bridge” is well laid out. During economic crises, a well-designed expansionary fiscal policy stance can contribute to better economic outcomes in two ways.
  • First, it can boost potential growth with multi-year public investment packages that raise productivity.
  • Second, there is a risk of the Indian economy falling into a ‘low wage-growth trap’, as has happened in Japan during the last two decades. Implementing the NIP via front-ended fiscal spending could generate higher-paying jobs and boost productivity.

Major Structural Reforms Undertaken as a Part of Atmanirbhar Bharat Package

Conclusion:

• The Economic Survey prescribes an expansionary counter-cyclical fiscal policy to usher growth and lower the debt-to-GDP ratio. It points out that it is not prudent to be too scared of debt.
• The Survey’s effort is thus to provide the intellectual anchor for the government to be more relaxed about debt during a time of economic crisis such as the one we are witnessing. Once growth picks up in a sustainable manner, it will be the time for fiscal consolidation.