
Prudent policy: India should not let public debt eclipse the fiscal deficit

Summary
- The Centre’s plan to adopt debt as its new focus for budget prudence after 2025-26 does hold merit, and a fast-growing economy can bear more of it, but we must not lose track of the fiscal gap. It’ll remain a valuable economic indicator for many reasons.
In a 2020 address to the nation soon after the outbreak of covid, Prime Minister Narendra Modi cited age-old wisdom that advised against losing control of three things: fire, debt and disease. To cushion India’s economy from the pandemic’s shock, though, government spending had to vastly exceed its inflows, taking its fiscal deficit to 9% plus of GDP in 2020-21.
The reversal of this debt-raising fiscal expansion since then has followed a glide path with 4.5% as the fisc’s aim, to be achieved by the next Union budget—for 2025-26. As no further target for it has been set, the Fiscal Responsibility and Budget Management (FRBM) Act’s goal of 3% looks likely to keep gathering dust.
Signalling a shift in approach, the last budget revealed an intent to target the level of public debt, rather than the annual fisc, in subsequent years as a way to keep overspending in check. This conforms with the PM’s prudent advice of 2020, but what exactly does it imply?
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Official data on the Centre’s debt burden, available till end-September, would place it about halfway between 55% and 60% of GDP, well above the FRBM ask of 40%. To North Block, the appeal of going by this metric might be its utility in keeping public debt within a safety limit, one that keeps the risk of a debt trap at bay.
Now, so long as the rate of nominal GDP growth—not adjusted for inflation, i.e.—exceeds the rate of interest paid on debt, the debt-to-GDP ratio will decline (if there’s no gap between revenues and non-interest spending). It’s the GDP effect: In a fast-growing economy, an administration with access to affordable credit can borrow and spend that much more, although fiscal restraint is still needed to prevent the deficit from overdoing that leeway.
In any case, the aim should be to reduce the public debt ratio, not just keep it from rising, given how interest payments at its current level eat up such a bulky chunk of funds, depriving the budget of money that could be spent usefully.
Debt that has piled up over the years can also be inflated away by the expedient ploy of letting price levels soar, as inflation reduces the real burden of debt. But this is plainly unfair to the country. This is also a reason a hawk’s eye will always need to be kept on the fiscal deficit.
If there exist short-run capacity constraints, a splurge of funds by the state could overheat the economy and make prices flare up. Keynes had proposed fiscal stimulus only as a device to rescue output and jobs from a demand slump (like the pandemic’s). Else, fiscal over-reach can be inflationary.
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Had India’s recovery in demand been broader, a 4.5% gap may have been a big worry for the central bank, whose job is to retain the rupee’s real value even if a fiscal pump makes rupee supply spurt. The trend of deficits also shows which way the carve-up of a country’s credit pie is going.
This helps assess the relative share of the state—versus market—in the allocation of an economy’s resources. A fiscal bloat involves borrowing that may crowd out loans to the private sector, an effect usually seen in rising bond yields and capital costs. Admittedly, this has not been the post-2020 case in India.
Private investment has seen only a partial revival, with the state playing the role of big-spender to drive GDP growth. The idea was to ‘crowd in’ private players, but hefty central outlays on capex now seem like the new normal. Yet, for faster growth, we still need a broad revival of ‘animal spirits.’
And the fiscal deficit will remain a useful economic indicator that must not get eclipsed by a focus on public debt.
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