Proceeds from monetisation of assets must be invested, not used to retrench debt

India is not exactly a shining example when it comes to containing government debt as a share of GDP, but nor does it rub shoulders with delinquents in this department. India’s debt/GDP is around 84%, Mint reported on 15 August. From an average debt/GDP of 70.6% for 2015-19, the figure shot up to over 88% in the worst Covid year of 2020. The debt burden, as a proportion of total economic output, jumped far more sharply for Japan, the US, the EU, the UK and at a comparable level for China. In the case of Japan and the US, the ratio is well over 100% and at 96% for the EU.

Conventional economic thinking would lay stress on bringing down the debt burden, in order to stop the cost of servicing debt pre-empting directly productive expenditure by the government. When a government sells off state-owned assets, it reduces the future stream of earnings from those assets. Sell off a profitable state-owned enterprise, and you stop getting dividends from it in the future. It makes sense to get rid of a matching quantity of liabilities on the government’s books as well, using the proceeds of the enterprise sale.

When you pay off a portion of past debt, two things happen: interest payments on the paid-off disappear. To the extent fresh borrowings are used, in part, to meet the repayment obligation on past debt, lowering the debt burden reduces the need to borrow for the sake of debt repayment as well. While everyone pays a lot of attention to the fiscal deficit, which is the amount of borrowing the government  has to do, in order to finance its expenditure over and above the level of non-borrowed receipts, a measure of fiscal health called the primary deficit does not get the attention it deserves.

The primary deficit is the difference between the gross fiscal deficit and interest payments. When the primary deficit is zero, the fiscal deficit equals interest payments. In other words, the government no longer relies on borrowings for any expenditure other than paying interest on past loans. This marks a turning point along the journey towards fiscal health. When the gross fiscal deficit turns less than interest payments, the government ceases to rely wholly on fresh borrowings to pay off interest, because its non-borrowed receipts are large enough to meet a part of the interest payment obligation, apart from other expenditure. When borrowings are smaller than interest payments, we have a primary surplus.

What the CEA says is that the government should lower the primary deficit, budgeted to be 2.3% of GDP in the current fiscal year, by paying off past debt, following the conventional wisdom that when you reshuffle your portfolio, reduction in assets should be matched by reduction in liabilities.

But now let us consider growth. The world has entered a low growth phase, as economies focus on containing inflation and raise interest rates. Export growth has been squeezed, high interest rates are depressing investments in general and squeezing venture capital. In such a scenario, for the government to revive growth, it is vital to quicken the pace of fresh investment. A vital source of capital that the government has identified to finance fresh investment is asset monetization.

Infrastructure is a tricky thing to build, especially in its high-risk early stages. So, if the government undertakes the early stages of infrastructure development, and once the risk of the project either getting indefinitely delayed, or even getting aborted has been removed, the project turns attractive, even before it starts producing a stream of returns. A project like a tolled highway, with a demonstrated stream of tolling revenue, becomes a prized asset for the likes of sovereign wealth funds and pension funds on the lookout for avenues of safe deployment with stable returns. The money the government gets from selling such an asset to a buyer at a decent price, it can put that money to building yet another highway or airport. That would generate fresh investment in private enterprises that supply the cement, steel, earthmoving equipment and other material required for the new infrastructure project. These investments would crowd in yet more investment in meeting the demand generated by those who find employment in the initial state-promoted project and the additional activity triggered in those who supply to that project.

In an election year, such as the present one, this is vital. All the more so since growth had been flagging in India even before the Covid pandemic. Now that the banks bad loan problem has been tackled, even if mostly by writing them off, banks are in a position to dole out large amounts of credit, provided there is demand for it. Fresh investment is required to create that demand.

So long as the growth generated by investing borrowed funds is higher than the cost of borrowing, that debt is sustainable, and the debt/GDP ratio would gradually come down.

The imperative of producing growth in a slowing world and politics trump conventional economic wisdom, Mr Nageswaran.