What debate? Reducing debt is the same as tightening the fiscal deficit.

This issue has been on the discussion table of late. The question is whether we should be obsessed with attaining a fiscal deficit of 3% or should we realistically look at achieving a debt-to-GDP ratio of around 60%. 

A notable point is that the fiscal deficit in itself may not be significant from the perspective of economic sustainability, but it is the most important component of future debt.

The fiscal deficit is financed mostly by borrowings by the central and state governments. These get added to the debt of the country. In India, typically, the debt ratio of the Centre is twice that of the states taken together. 

In 2023-24, for instance, the states had a debt-to-GDP ratio of 28.2%, while the Centre’s was double that proportion, at 57.1%, taking the country’s total to 85.3%.

Also read: Debt, not deficit: Aim for more clarity in next-generation of fiscal rules

It has been observed that the Centre’s debt ratio increased sharply from 50.7% in 2019-20 to 60.7% in covid-year 2020-21, mainly on account of its fiscal deficit ratio doubling to 9.2% of GDP. 

A similar rise was observed for states, although their combined debt ratio rose less steeply, from 26.6% to 31.1%, with their deficit ratio rising from 2.6% to 4.1%. In years when the fiscal deficit ratio came down, the debt-to-GDP ratio also moved south, and vice-versa. It is certain that only when the fiscal deficit is reduced can the debt-to-GDP ratio come down.

What is open to discussion is whether India’s fiscal deficit ratio should be 3% or 4%. As for debt, if we go by the latest norms set under the Fiscal Responsibility and Budget Management Act, the debt-to-GDP level should be 40% for the Centre and 20% for states, taking the combined figure to 60%.

Is a debt level of 60% reasonable? Globally, countries which issue currencies that are accepted for cross-border payments and are held as reserves by others have tended to sustain higher levels of debt. In 2023, US debt was 122% of GDP, while the UK’s was 101%. Japan had the highest level of 252%. 

For the Eurozone, it was 89%. Within it, Germany was at 64%, while France and Italy had debt levels of 110% and 137%, respectively. Switzerland had a ratio of just 38%. Among emerging markets, India’s ratio is comparable with China’s and Brazil’s, which had 84% and 85%, respectively. 

South Africa’s was 74%. This global picture makes a target of 60% appear too aggressive. Instead, a level of around 70-75% could be India’s final goal, though the glidepath towards it must take our development aims into account.

Also read: Centre aims to reduce debt-GDP ratio by 1 percentage point annually till it reaches 50%

The broader issues that need attention relate to the attributes of government borrowing. For one, the quality of spending (done with partly borrowed money) needs to be fine-tuned to ensure the desired impact. 

It is true that money is fungible and it’s hard to separate expenditure for economic purposes from general spending. But we need to set a target for what portion is deployed as capital expenditure, which can support further income generation and thus counts as better-quality spending.

Second, the tenure of borrowings is important. The government’s tendency has been to borrow for maturity periods of over 10 years. In 2023-24, over half its debt was in this bracket. 

While it helps to spread out repayments, these debt securities reside on the books for that much longer and become sticky elements over time in the government’s outstanding debt.

The third issue relates to the cost of borrowing. Shorter tenures cost less and would be beneficial, as interest costs account for around 25% of the 2024-25 Union budget’s aggregate outlay of ₹48.20 trillion.

So the debate is not really about targeting a 60% or 70% debt-to-GDP ratio versus a fiscal deficit ratio of 3% or 4%.

The real concern is that as we embark on a journey to lower the government’s debt and deficit levels, its budget may run into a ‘fiscal cliff.’ This refers to a massive obstacle that confronts a government that borrows less to keep its deficit and debt in check, but also has substantial expenditure commitments. 

In our case, these would include subsidies, farmer payouts and various schemes, among other programmes. The Centre’s fiscal deficit target for 2024-25 is set at ₹16.13 trillion, which amounts to a ratio of 4.9%. 

Assuming it reaches 4.5% next year and is reduced by half a percentage point in every subsequent year, with nominal GDP growth of 11%, the deficit will come down numerically to less than the 2024-25 level by 2027-28. 

To sustain inflation-adjusted outlays on social welfare, revenue growth must accelerate. This may prove hard, as optimal levels may already have been reached. In such a situation, it could be a challenge to rein back expenditure to get the country’s fiscal and debt ratios down.

Also read: Spare the fisc: Don’t run rings around the budget deficit

Understandably, improving India’s fiscal parameters are a matter of concern. But, given the global context, our ratios are not out of sync with numbers in other countries. 

While lowering public debt will relieve the government of its debt-servicing burden and release funds for other developmental activities, the path taken should be cognizant of our particular economic conditions, with the Centre playing a major role in welfare and infrastructure development.

All considered, the path we are currently on appears appropriate.

These are the author’s personal views.