India’s Public Debt

2024 JAN 5

Mains   > Economic Development   >   Budgeting   >   Union budget

Syllabus: GS 3> Economic Development   >   Budgeting   >   Union budget

 

REFERENCE NEWS:

  • Recently, the International Monetary Fund (IMF), in its review (the annual Article IV consultation report), claimed that India's general government debt, which includes federal and state government debt, could be 100 percent of GDP under adverse circumstances by fiscal 2028.

MORE ON NEWS:

  • According to the report, “long-term risks are high because considerable investment is required to reach India’s climate change mitigation targets and improve resilience to climate stresses and natural disasters. This suggests that new and preferably concessional sources of financing are needed, as well as greater private sector investment, carbon pricing, or an equivalent mechanism.” 
  • The Finance Ministry refutes IMF projections as this is “a worst-case scenario and is not fait accompli.”

PUBLIC DEBT:

  • Public debt, also known as government debt or national debt, refers to the amount of money that a government owes to creditors.
  • In other words, public debt is the total liabilities of the central government contracted against the Consolidated Fund of India.
  • Public debt occurs when the government's revenue from taxes and other sources falls short of its spending requirements and has to resort to borrowing from markets and external sources. Public debt is further classified into internal and external debt

INDIA’S PUBLIC DEBT:

  • As of March 31, 2023, the total debt of the Central Government of India was reported to be Rs 155.6 lakh crore, equivalent to 57.1% of the country's Gross Domestic Product (GDP).
  • This figure represents a reduction from 61.5% of GDP in the fiscal year 2020-21, indicating a gradual decrease in the debt-to-GDP ratio over this period. (This information was provided by the Minister of State for Finance in a written reply to the Rajya Sabha.)
Debt-to-GDP ratio
The debt-to-GDP ratio indicates how likely the country can pay off its debt. Investors often look at the debt-to-GDP metric to assess the government's ability to finance its debt. Higher debt-to-GDP ratios have fuelled economic crises worldwide.

POSITIVE IMPACTS OF GOVERNMENT BORROWING:

  • Economic Growth: Borrowing enables governments to invest in infrastructure and public services, stimulating economic growth.
  • Managing Economic Cycles: It can be used to smooth out economic fluctuations, boosting spending during downturns to stimulate the economy.
  • Spreading Costs: Borrowing allows governments to spread the cost of significant investments over time, making it more manageable.
  • Leveraging Future Revenue: It enables the government to leverage future revenue for present needs without increasing taxes immediately.
  • Emergency Funding: Provides a crucial source of funds during emergencies, like natural disasters or economic crises.

WHY MANAGING PUBLIC DEBT IS A CRITICAL ASPECT OF A GOVERNMENT'S FISCAL POLICY

  • Credit rating and investor confidence:
    • Elevated debt levels and substantial costs associated with servicing debt impact the credit rating of the country. The lower credit rating may impact investor confidence, reduce FDI/FII, and make future borrowing expensive.
    • For instance, despite its status as the fastest-growing major economy, India has been consistently rated 'BBB-', the lowest investment grade, by credit rating agencies since 2006, citing concerns over its fiscal discipline and high government debt, even with its strong economic fundamentals.
  • Impacts fiscal capabilities of the government:
    • As borrowing increases, the government has to pay more interest rate payments to bondholders. This can lead to a greater percentage of tax revenue going to debt interest payments.
  • Crowding out effect:
    • As more money is lent to the government rather than invested in the market, corporate sector is crowded out leading to slower industrial and capital asset growth and potential loss of employment.
  • Fiscal repression of commercial banks:
    • When the government borrows more, it forces Public Sector Banks to purchase more of Government Securities (GSecs) which reduces the capital availability to the private sector and affects profitability of the banks.
  • Inflationary pressure:
    • High debt can force governments to print money and thus lead to inflation and reduction in real interest rates.
  • Exchange rate risk:
    • The reduced demand of domestic securities relative to foreign securities (due to poor credit rating) might push the exchange rate down and weaken the domestic currency.
  • Higher taxes in the future:
    • If the debt to GDP rises rapidly, the government may need to increase taxes and/or limit spending to reduce debt levels in the future.
  • Vulnerability to volatile international capital markets:
    • High share of external debt exposes economy to capital flight.
GOVERNMENT INITIATIVES TO MANAGE PUBLIC DEBT:
  • Public Debt Management Agency (PDMA):
    • A dedicated statutory agency to manage India's external and domestic debt under one roof
  • Fiscal Responsibility and Budget Management Act:
    • The primary objective was the elimination of revenue deficit and bringing down the fiscal deficit.
    • The other objectives included:
  • Introduction of a transparent system of fiscal management within the country
  • Ensuring equitable distribution of debt over the years
  • Ensuring fiscal stability in the long run
  • NK.Singh Committee to review the FRBM Act, 2003:
    • Debt to GDP ratio:
  • It recommended that the debt-to GDP ratio should be 40% for the Centre and 20% for the States, respectively, by 2023.It said that the 60% consolidated Central and State debt limit was consistent with international best practices, and was an essential parameter to attract a better rating from the credit ratings agencies.
  • Revenue deficit: Committee recommended that revenue deficit should be reduced to 0.8% of GDP by March 31, 2023.
  • Fiscal deficit target: Fiscal deficit should be reduced to 2.5% of GDP by March 31, 2023. 
  • Debt Management Strategy (DMS) by the RBI:
    • RBI act as agent of the government to implement the borrowing programme and it draws necessary statutory powers for debt management from Section 21 of the Reserve Bank of India Act, 1934
    • The objective of the debt management strategy (DMS) is to secure the government's funding at all times at low cost over the medium /long-term while avoiding excessive risk
    • The DMS has been articulated in medium-term for a period of three years and it may be reviewed annually and rolled over for the next three years.
    • DMS of RBI involves the following pillars:
      • Low Cost: Extending debt maturity, aligning small savings and other rates with market rates.
      • Risk Mitigation: Setting benchmarks for short-term and external debt, Floating Rate Debt to minimize rollover and rate/exchange risks. E.g., short-term debt capped at 10% ± 3% of total marketable debt.
      • Market Development: Ensuring transparency, regular investor interactions, issuing diverse instruments, nurturing domestic investors, and gradual opening to foreign investors.

 

WAY FORWARD:

  • Enhanced Economic Growth Strategies: 
    • Stimulate economic growth to increase tax revenues and reduce debt-to-GDP ratio. Encourage high growth sectors like technology, manufacturing, and services.
  • Tax Reforms and Revenue Enhancement: 
    • Implement comprehensive tax reforms to widen tax base and improve tax collection efficiency. 
  • Public-Private Partnerships (PPPs): 
    • Promote PPPs to attract private investment in infrastructure and other key sectors, reducing government financial burden.
  • Prioritize Investments: 
    • Borrow for productive investments like infrastructure, education, and healthcare, not for recurrent expenses or inefficient projects.
  • Debt Restructuring and Management: 
    • Restructure debts to more favorable terms, with longer maturities and lower interest rates. Enhance debt management through Public Debt Management Agency (PDMA) and other initiatives.
  • Diversifying Funding Sources:
    •  Seek alternative funding sources like sovereign, diaspora, and green bonds. Attract more foreign direct investment (FDI) and foreign portfolio investment (FPI) for development projects.
  • Monetary Policy Coordination: 
    • Coordinate with Reserve Bank of India (RBI) to align monetary policies with debt management strategies.
  • Strengthening Financial Institutions: 
    • Enhance banking sector to improve credit availability and reduce government borrowing reliance. Implement reforms for robust financial institutions supporting economic growth.
  • Building Foreign Exchange Reserves: 
    • Increase foreign exchange reserves for a buffer against external debt obligations and currency volatility.
  • Enhancing Transparency and Accountability:
    •  Improve transparency in public debt reporting and management. Conduct regular audits and public reviews of government expenditures and debt levels.
  • International Cooperation and Assistance: 
    • Seek assistance and advice from international bodies like IMF and World Bank.

PRACTICE QUESTION:

Q. “India's public debt management should maintain fiscal discipline while meeting the developmental needs of its population.” Discuss. (15 marks, 250 words)