Shedding more light on the debt dilemma – Analysing the public debt status | 27 July 2023 | UPSC Daily Editorial Analysis

What's the article about?

• It talks about the status of the public debt, its impact on the overall economy and offers some suggestions.

Relevance:

• GS3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment; Government Budgeting;
• Prelims

Context:

• The elevated levels of India’s fiscal deficit and public debt have been a matter of concern for a long time in India.
• Even before the COVID-19 pandemic, debt levels were among the highest in the developing world and emerging market economies. The pandemic pushed the envelope further and, relative to GDP, the fiscal deficit in 2020-21 increased to 13.3% and the aggregate public debt to 89.6%.
• As the economy recovered after the pandemic, the deficit and debt ratios have receded to 8.9% and 85.7%, respectively.

Analysis:

• Negative consequence of the high public debt:
  • Financial repression:
    • The debt-dynamics equation states that when there is no primary deficit (fiscal deficit in the year excluding the past legacy of interest payments), if the growth rate of GDP exceeds the effective interest rate paid on government bonds, the overall debt will decline.
    • But, measures taken by the government to keep the interest rates on government borrowing low to reduce the cost causes a distortion in the market. This results in financial repression.
  • High cost of keeping debt sustainable:
    • This reduces the government’s spending ability in other sectors, such as the social sector. For example, on average, interest payments constitute over 5% of GDP and 25% of the revenue receipts, this is more than the government expenditure on education and health care put together.
    • Large interest payments crowd out the much-needed expenditures on physical infrastructure and human development and emerging priorities to make the green transition.
    • The issue is of concern in Punjab, Kerala, Rajasthan, and West Bengal. In Punjab, the Debt to GSDP ratio is 48.9%, in West Bengal, 37.6%, Rajasthan 35.4%, and in Kerala close to 33%.
  • Reduces the efficacy of government's efforts: High levels of debt make it difficult to calibrate counter-cyclical fiscal policy and constrain the ability of the government to respond to shocks.
  • High cost of borrowing for the private manufacturing sector due to the captive nature of the debt market.
  • Affects the ratings: The rating agencies keep the sovereign rating low when deficits and debt are higher, and this increases the cost of external commercial borrowing.
  • Finally, ‘today’s borrowing is taxing tomorrow’ and the burden of large deficits and debt will have to be borne by the next generation.
• Measures to improve status of public debt:
  • Need for fiscal consolidation:
    • The 14th Finance Commission had recommended that the Union government bring down its deficit relative to GDP from 43.6% in 2015-16 to 36.3%, and the States maintain their deficit at about 22%.
    • But, even before the pandemic, the aggregate public debt had slipped to 74.3% in 2019-20, and the pandemic pushed it to 89.7% in 2020-21.
    • With the nominal GDP recovering to grow at 18.5% in 2021-22 after the pandemic, the debt ratio declined only marginally to 85.7%. This implies that every individual in the country bears a debt burden of ₹ 1,64,000.
    • Thus, the government needs to act swiftly and work on fiscal consolidation.
  • The following measures can be considered in this regard:
    • Enhance the role of GST:
      • After six years, Goods and Services Tax (GST) has stabilised and has shown high growth potential. As the technology platform has stabilised, it is expected to maintain high buoyancy in the medium term.
    • In terms of policy interventions, this is the time to rethink the role of the state and vacate activities that should really belong to the market rather than competing with it.
      • At the central level, even after much talk about disinvestment, progress has been slow.
      • At the State level, it is important to guard against the return to the old pension scheme and indulge in large-scale giveaways for electoral reasons.
    • Follow the provisions made in the Fiscal Responsibility and Budget Management Act in true spirit.
    • Role of Union Government:
      • Macroeconomic stabilisation is predominantly a Union government responsibility. Therefore, the Union government should follow the rules it makes, and enforce the rules on the States effectively.

Way Forward:

• The long-term consequences of the higher debt are not good for India's growth trajectory. The Union and State Governments must work in tandem to achieve the targets set by the FRBM Act and Finance Commissions.