For decades, emerging economies had reason to envy advanced countries for their fiscal and monetary credibility. Their governments borrowed more cheaply and their sovereign bonds were regarded as safe assets. That distinction is blurring.
The US, UK, France and Japan now confront elevated sovereign bond yields. Large US deficits co-exist with strong growth; Japan faces rising yields after decades of near-zero rates; France and the UK face high debt with difficult fiscal choices. Chinese yields remain unusually low, but this reflects weak domestic demand rather than fiscal strength.
There are lessons for India. First, high public debt can remain manageable for a remarkably long time—until the environment sustaining it changes. Low interest rates allowed advanced economies to accumulate debt with limited immediate consequences.
Inflation and monetary tightening have transformed that arithmetic. Sovereign bonds once treated as safe assets can themselves become sources of instability. India’s overall public debt remains around 81% of GDP and the combined Centre-state fiscal deficit above 7%.
Yet, India’s position differs: growth is relatively strong, debt is overwhelmingly domestic and foreign-exchange reserves provide an external buffer. Growth is thus India’s most important fiscal asset. But it must be protected. UK Chancellor John Healey put the principle well when he said maintaining fiscal credibility was ‘indivisible’ from the drive for growth.
The same applies to India. Debt sustainability depends on future growth, interest rates, inflation and confidence in fiscal institutions. Fiscal consolidation that undermines productive investment can weaken growth; borrowing that hurts fiscal credibility can do so as well.
Second, what government debt finances matters as much as how much it borrows. India has enormous investment needs. But what counts as capital expenditure needs greater clarity.
India’s budgetary definition includes not only spending that creates physical assets but financial investments, loans and other transactions that do not directly add to productive physical capacity.
Borrowing that builds productive infrastructure and eases bottlenecks expands future income from which debt can be serviced. Financial assets may support this, but are not the same. The test is what asset is created and what economic return it generates.
Third, India should guard against fiscal dominance. As debt and interest costs rise, governments have a stronger interest in keeping credit costs low, potentially pressuring monetary policy to accommodate fiscal needs.
The Reserve Bank of India’s inflation objective and operational independence are therefore fiscal assets: monetary credibility lowers inflation risk and the related premium investors demand on long-term debt.
India’s large domestic investor base offers protection, but not immunity. Japan’s case demonstrates the limit: when inflation and monetary policy normalizes, yields can rise even in a domestically financed market. Domestic savings are a buffer, not an unlimited fiscal resource.
Higher US, European and Japanese yields raise the global price of capital. Emerging economies increasingly compete for savings with heavily indebted advanced-country governments and technology companies financing enormous AI investments.
For India, this can mean higher bond yields, rupee pressure and dearer corporate loans. India’s integration with global bond markets diversifies its investor base but also increases sensitivity to global portfolio shifts. Instability originating in advanced bond markets could hit emerging economies disproportionately.
India should use today’s high-growth environment to strengthen fiscal buffers before global conditions harden. Fiscal consolidation must continue without pullback in high-return physical investment. India must also address state-level vulnerabilities and contingent liabilities: fiscal sustainability is an all-government requirement.
Investors discriminate among sovereign markets by growth prospects, inflation credibility, institutional strength and diversification benefits—not simply whether the bond issuer is advanced or emerging. India could benefit.
Note how Japan’s Credit Rating Agency has upgraded India’s rating, returning its sovereign debt to the A category for the first time since 1988. It cited high growth, public investment, banking-sector improvement and structural reforms. The upgrade is an external vote of confidence. But it reinforces the argument that global credibility requires India to achieve growth on a stable fiscal foundation.
Sustaining this advantage requires stronger private investment, alongside greater R&D and innovation. Infrastructure, skills and research capacity attracting more global AI investment could strengthen private investment as an engine of growth.
The final lesson is that India’s current ability to borrow should not be confused with tomorrow’s capacity to service debt comfortably. Thankfully, India has what some highly indebted advanced economies lack: favourable growth dynamics and substantial scope for productive investment. The challenge is to retain that edge by strengthening fiscal buffers, monetary credibility and the productivity of public outlays.
Bond markets can remain forgiving for a long time, but not indefinitely. India’s best defence against a new era of dearer global debt is its economic growth. But growth and fiscal credibility are mutually dependent. Fiscal policy, especially the quality of what public debt finances, must aim for both.
The author is a distinguished fellow at the Centre for Social and Economic Progress (CSEP) and a former member of the 15th Finance Commission