How much should a person or firm be allowed to borrow? Or to put it differently, at what stage does contracting of loans become an unsustainable proposition?

A general rule of the thumb is that debt must not reach a point where it starts to build on itself. That happens when (a) it expands faster than one's income and (b) the cost of servicing it increasingly takes up large share of income.

So, how does this prudent rule apply to debts accumulated by the Government of India? The usual way is to compare it with the country's gross domestic product (GDP).

Between 1992-93 and 2002-03, the Centre's outstanding liabilities – all forms of internal and external obligations on which it incurs interest – rose from 51.9 to 61.6 per cent of GDP. The interest-GDP ratio, too, went up from 4 to 4.7 per cent.

While interest payments were already eating up almost 42 per cent of total tax and non-tax revenues in 1992-93, this proportion had crossed 50 per cent by the turn of the century. In other words, both debt and the cost of servicing it were rising at a higher rate than income.

Now, that was clearly unsustainable.

THE GROWTH EFFECT

But these ratios have since registered significant improvements. Not because the Centre stopped borrowing.

On the contrary, between 2002-03 and 2011-12 (Revised Estimates), its outstanding liabilities have grown by some 187 per cent, from Rs 15.6 lakh crore to almost Rs 45 lakh crore. Simultaneously, interest payments on them have risen by 134 per cent, from Rs 117,804 crore to Rs 275,618 crore.

What has made the difference, however, is GDP at current market prices. This went up by a huge 252 per cent from 2002-03 to 2011-12. As a result, both debt as well as interest payments fell as a percentage of GDP.

The question to ask is how much of this improvement was inflation-aided?

Out of the nominal GDP increase of 252 per cent between 2002-03 and 2011-12, the growth at constant prices was about 140 per cent. The balance has come from inflation, which has certainly helped lighten the Centre's debt load or erode its real value. A case of ‘inflating-away' one's debt!

But that does not still mean there has been no improvement. The best measure of it is in the last column of the table, which shows interest payments as a percentage of the Centre's revenue receipts.

That has gone down from over a half or about a third in the last ten years. Since estimates of revenue, unlike GDP, can be relied upon, any reduction in its share going towards servicing of debts signifies ‘real' improvement.

So, what is the broader story? Well, it has to do with growth. Strong growth not only boosts GDP denominator values, but also positively impacts the Centre's revenue collections, making it easier to service existing liabilities.

The improvement seen in the Centre's debt indicators has been brought largely by growth, rather than any self-imposed austerity.

That, in turn, raises questions over the obsession with austerity, which the Centre professes (‘fiscal consolidation') but hardly practises. Does austerity pay at all? Should the Centre's target be austerity or growth?

The Indian experience of the recent period shows that it is growth – by working through the revenue side – that pays.

AUSTERITY doesn't work

On the other hand, austerity – involving cutbacks in expenditures – adversely impacts both growth and revenues.

This has been demonstrated in Europe and even India during the late nineties to the early 2000s, which was a period of relative austerity.

It makes sense, then, for governments to make obsession with growth, so to speak, the focus of their policies.

That is what would distinguish the economist's approach from that of a mere accountant (which is what many policymakers nowadays revel in). An accountant inherently looks at all expenditures with suspicion. For an economist, on the other hand, any expenditure should be welcome, so long as it is growth-promoting and puts more money in the hands of the people.

Therefore, it is not easy to put a number on what is an acceptable level of public debt, beyond which it ‘crowds out' private investment or stokes inflation. It could vary from country to country.

Developed economies such as Japan (208 per cent), Canada (83.5 per cent), UK (79.5 per cent) and the US (69.4 per cent) have higher public debt to GDP ratios, as do some emerging economies such as Vietnam (54.5 per cent), Malaysia (57.9 per cent) and Brazil (54.4 per cent).

As is well known, Greece, Portugal, Italy and Ireland have ratios in excess of 100 per cent; their debt has assumed crisis proportions not because of the level per se, but because they cannot redeem it in their currencies.

The US, the UK and Japan are, therefore, not considered to be in a financial mess, despite their considerably higher levels of public debt, because it is denominated in their respective currencies.

Over 96 per cent of India's public debt (of Rs 45 lakh crore) is held in rupees, or owed to the people of India. External liabilities of the Government of India were Rs 1.68 lakh crore (2011-12 revised estimates).

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