The struggle to stem our growing public debt

Much has changed since Roosevelt said what he did. These days governments all around the world regularly spend more than what they earn. The difference between what a government earns and what it spends is referred to as the fiscal deficit. In India, the government borrows to finance the fiscal deficit by issuing bonds which pay interest and by getting people to invest in small savings schemes run primarily by the post office. Hence, the fiscal deficit that the government incurs adds to its overall borrowing.

In the budget presented by the finance minister Nirmala Sitharaman on 1 February, it was revealed that the expected fiscal deficit for 2022-23 will be at ₹16.6 trillion, or 6.4% of the gross domestic product (GDP). GDP is the measure of the economic size of a country during a given year.

The high fiscal deficit for 2022-23 will come on the back of very high fiscal deficits for two consecutive years. The fiscal deficit for 2020-21 was at ₹18.2 trillion or 9.2% of the GDP. The fiscal deficit for 2021-22, the current financial year, is expected to be at ₹15.9 trillion or 6.9% of the GDP. These high fiscal deficits have been financed through increased borrowings and the government taking on higher liabilities in the form of greater investments made into small savings schemes.

The total liabilities of the central government as of March 2023 are expected to be at ₹152.2 trillion (see Figure 1). From March 2020 and March 2023, in a period of three years, the government would have ended up adding ₹50 trillion to its liabilities. To give some context, the central government would have accumulated more debt in the three years since the pandemic began, than it had in the seven years before the pandemic. Of course, these numbers are in absolute terms.

Borrowing can be a double-edged sword. It enables countries to finance initiatives that spur growth and provide important services to its citizens. This becomes particularly important during periods when economic growth has been hit, as it has been due to the spread of the covid pandemic. Hence, borrowing, within a certain limit, can be positive for a country and be a catalyst for development. But too much borrowing can drag an economy down when servicing past borrowing overwhelms government finances.

Hence, is our current debt situation a cause for concern? This piece tries to figure out.

A debt cycle

First and foremost, it is important to mention here that India is not the only country in the world which has had to borrow more, in order to keep the government and the economy going. It’s a global phenomenon.

The Economist recently pointed out that the government debt of advanced economies jumped by 20 percentage points to 123% of their GDP. In emerging economies, the jump was nearly 10 percentage points to 63%. The liabilities of the Indian central government in 2020-21 were at 61% of the GDP. With state government liabilities added, it was at 91.3% of the GDP.

While higher debt helps governments in the short to medium term, it does have its fair share of costs as well. The government needs to pay interest on the bonds it issues in order to finance the fiscal deficit. In 2022-23, the central government is expected to spend ₹9.41 trillion or 3.6% of the GDP on paying interest on the bonds. Interestingly, this forms around 48.6% of the total net tax revenue that the central government hopes to earn during the year.

Hence, in 2022-23, the government will end up spending close to half of its tax revenues on paying interest on its borrowings through bonds. This is up from 42.6% in 2017-18. This shows that the costs of higher borrowings accumulate down the years, leaving the government with lesser money to spend on other important things—everything from education to health—unless it raises more money from other sources like disinvestment, dividends received from public sector companies or continued higher borrowing.

If the government borrows more, as the Indian government is likely to in the next few years, then a major portion of its tax revenue continues to go towards paying interest on the debt, leading to the government having to continue with higher borrowings. In this way, the government tends to get stuck in a debt cycle, something that becomes clear after looking at Figure 2, which plots the central government liabilities as a percentage of the GDP.

Figure 2 clearly shows that while the total liabilities of the central government can go up very fast, they take time to come down. In 2002-03, the central government liabilities stood at 62.6% of the GDP. This came in the aftermath of the dotcom bubble bursting. They fell to a low of 48.1% only in 2018-19, sixteen years later.

Pandemic’s curse

Yet another point needs to be considered. Other than the central government, the state governments are also borrowing and committing to liabilities. The overall liabilities of the government, thus, are a sum of central government liabilities and state government liabilities (See Figure 3).

Figure 3 makes the same points as Figure 2. The total government liabilities peaked in 2004-5 at 95.1% of the GDP. It took 11 years for the liabilities to come down to the recent low of 72.1% of the GDP in 2014-15. This clearly shows that a debt cycle isn’t easy to come out of. Besides, the state government liabilities have been going up from 2014-15 when they were at 22% of the GDP. By 2019-20, before the covid pandemic struck, they were already at 26.6% of the GDP. They jumped to 30.3% in 2020-21, when the total government liabilities reached 91.3% of the GDP. In 2021-22, the liabilities are expected to be at 88.4% of the GDP.

A bulk of the recent increase is due to the expenditure related to the pandemic, everything from giving away free grains to putting money directly in the bank accounts of people. Some of the increase is also due to good accounting practice and ensuring that the off-budget spending carried out by the Food Corporation of India and the National Highways Authority of India is included in the central government’s budget, going forward. Of course, the contraction in the GDP in 2020-21, also sent the total liabilities as a percentage of the GDP soaring.

In a column in the Business Standard, Neelkanth Mishra, co-head of APAC Strategy and India Strategist for Credit Suisse, estimates that the total government liabilities in 2022-23 should come down to 81% of the GDP. Mishra is more optimistic about the growth in the GDP and tax collections than the government has assumed in the budget. He might turn out to be right in the short-term, thanks to the well-offs spending more and increasing formalization of the economy, with big business dominating and many small businesses shutting down.

But eventually, the K-shaped economic recovery, which is being seen in the demand for work under the Mahatma Gandhi National Rural Employment Guarantee Scheme remaining high and the domestic two-wheeler sales in 2021-22 being at a 10-year low, is bound to have an impact on economic growth and tax collections. On top of that there is both domestic and global inflation to contend with.

Unmet goals

It needs to be mentioned here that from 2012-13 to 2018-19, the total government liabilities moved in the close range of 72-73%. Even this level was considerably higher compared to India’s peers. This was a point made by a committee of economic experts headed by N.K. Singh, which, in January 2017, submitted a report recommending changes to the Fiscal Responsibility and Budget Management Act (FRBMA) with an eye towards fiscal prudence.

The committee recommended managing public debt levels as a policy objective, stating that it “believes that a transparent and predictable policy framework is one that is rule-based."

The report offered four economic arguments favouring such an approach. First, it would ensure the government would stay solvent. Two, a rule-based approach of combining debt ceiling and fiscal deficit targets would provide continuity and stability to the fiscal framework. Three, at that time, India’s liabilities-to-GDP levels of 70% were already among the highest in its peer group of emerging markets. And four, the level of public debt was a key factor used by global rating agencies which affects both cost of borrowing and foreign investments.

To operationalize their recommendations, the committee laid out a road-map to reduce total government debt (liabilities) to around 60% of GDP. “The central government shall endeavour to limit the general government debt to 60% of GDP and the central government debt to 40% of GDP, by 31 March, 2025," the government pointed out in the latest statements on fiscal policy required under the FRBMA.

Of course, this is unlikely to happen due to the pandemic. In fact, the Economic Survey of 2020-21 argued that the fixation with government borrowings may be counterproductive, as the economy emerges from the pandemic. It makes a case for relaxing strict borrowing and deficit targets to allow the government some space to increase spending, even if that leads to higher levels of debt.

Taking this into account, it is highly unlikely that the total government liabilities will come down to pre-pandemic levels anytime soon. Also, it is important to remember that the Lok Sabha elections are due in mid-2024. Hence, the next year’s union budget is likely to be an expansionary one.

Further, the performance of the Bhartiya Janata Party (BJP) in the Uttar Pradesh elections, scheduled this month and the next, will have an impact on how expansionary next year’s budget is likely to be. The weaker the party’s performance, the more expansionary the budget is likely to be. In fact, the bond market is already taking this into account, with the 10-year bond yield rising close to 6.7%. It was at 6.4% at the beginning of the year. The yield on a bond is defined as the annual return an investor can expect by holding on to the bond until it matures. A rising bond yield signifies that bond market investors want a higher rate of return on their current and future investments. In the current scenario, this is primarily because of rising inflation as well as the chances of government borrowing continuing to remain on the higher side.

To conclude, while the government’s liabilities will take time to come down, the good thing is that almost all of these liabilities are owed in rupee terms and there is very little that the government owes to foreigners.

Also, in this scenario, it is important that the government look at other sources of receipts, including disinvestment and land sales, and allow foreign money into some of these areas. Otherwise, the government will end up tapping the same limited pool of domestic savings.

(Vivek Kaul is the author of Bad Money and Chintan Patel is a freelance writer.)