How to make public debt sustainable

In its recent research report, Morgan Stanley forecasted that India will be included in global bond indices in early 2022 and this will result in investment inflow of $170-250 billion into the Indian sovereign bond market during the next decade. Of late, the Indian bond market has been in the news for various reasons. Out of all, sustainability of public debt is one of the critical issues from the point of view of policymakers.

Before Independence, the borrowing needs of Indian princely states were largely met by indigenous bankers and financiers. The concept of borrowing from the public was pioneered by the East India Company to finance the Anglo-French wars during the 18th century.

The First World War saw a rise in India’s public debt due to the country’s contribution to the British exchequer. The provinces of British India were allowed to float loans for the first time in 1920 when the local government borrowing rules were issued under the Government of India Act, 1919.

Burgeoning public debt

India’s public debt (combined liabilities of the Central and State governments) to gross domestic product (GDP), at constant prices, increased to a record high of 100.86 per cent in 2020 as against 76.86 per cent in 2014, as per the data from the Reserve Bank of India.

Now, India has become the most indebted nation after Brazil and Argentina among the emerging market economies. In South Asia too, India is the most indebted after Bhutan and Sri Lanka. Interestingly, Brunei, United Arab Emirates, and Russia have low debt-to-GDP ratios with 2.46 per cent, 19.35 per cent, and 19.48 per cent respectively.

It is well-recognised that excessive public debt leads to higher risk premium in interest rates, which results in reduction of private investment (crowding out effect) as well as contraction of GDP in the long run. Though an increase in public debt will stimulate aggregate demand and output in the short-run, the economic growth will turn negative in the long run if the debt-GDP ratio exceeds 90 per cent (Reinhart, Reinhart, & Rogoff, 2015).

Suggested measures

Therefore, the following measures may be adopted by the government to make public debt sustainable in the medium to long term.

Privatisation of loss-making PSUs: By applying STEEPLE test, the government may think of privatising loss-making public sector undertakings (PSUs) such as Air India. Specifically, the government may run any business if it is Socially relevant, Technologically feasible, Environmentally friendly, Economically viable, Politically acceptable, Legally unassailable, and Ethically right.

Further, ‘minimum government and maximum governance’ principle may be adopted in privatising any PSU.

Prudential stance: As per the Fiscal Responsibility Budget Management (FRBM) Act 2003, it is the onus of the government to control fiscal profligacy and to achieve long term macro-economic sustainability through effective conduct of monetary policy and prudential debt management in a transparent manner. In line with this, the RBI has been sensitising States such as Chhattisgarh, Goa, Manipur, etc., about prudential measures of cash and debt management.

This needs to be extended to all States with a view to adhering to fiscal deficit targets and debt-GDP ratios. Under the banner of co-operative federalism, the Central and State governments should undertake robust expenditure planning to address the socio-economic challenges without diluting the goals of fiscal consolidation.

Leveraging of PFMS: The Central Government has been implementing over one thousand social welfare schemes through its various ministries with an annual expenditure outlay of around ₹3-lakh crore.

As part of better fiscal deficit management, maintaining enhanced transparency and accountability, the Public Financial Management System (PFMS) should be leveraged to the maximum possible through real-time, consolidated and granular data on advances, transfer of funds and utilisation.

PPP model in social schemes: The government may think of public private partnership (PPP) model in social schemes such as Deen Dayal Upadhyay Grameen Kaushalya Yojna (DDU-GKY).

Essentially, contribution in cash or kind, from the project implementing agencies in private sector may be thought of when the captive/champion employers are sourcing the skilled trainees for their operations in order to reduce the fiscal burden of the government.

Investment in infrastructure: According to RBI data, gross fixed capital formation (GFCF) to total combined liabilities of Centre and States ratio was 37.47 per cent as of March 31, 2019, when compared to 45.77 per cent as on March 31, 2014.

Since the public debt has been translated into lower level of new fixed assets during this period, the government needs to focus on investment in infrastructure and human capital for realising the multiplier effect.

Harmonisation of tax regime: Though Goods and Services Tax (GST) subsumed almost all the indirect taxes, it is not applicable to alcohol, petroleum products, electricity, etc., as on date. Besides, multiple GST rates are in vogue. Hence, GST needs to be harmonised and expanded to other areas to reach national consensus with a view to improving the tax-GDP ratio. Besides, the government should create an investor-friendly environment for additional source of financing to replace the high public debt.

Thrust on renewable energy: India imports nearly 80 per cent of its domestic requirement of crude oil. India can become a $5 trillion economy by 2025 if it gives more thrust on renewable energy by reducing its reliance on fossil fuels, thereby saving on foreign exchange.

Further, the government should enhance efficiency of public debt management by adhering to the canons: low cost, risk mitigation and market development.

This can be a reality when it maintains prudent risk profile with low roll-over risk, relatively long maturity of outstanding debt predominantly fixed rate coupon securities insulating it from interest rate volatility, calibrated opening of G-Sec market to foreign investors, and huge diversified investor base.

In sum, the government should make the public debt sustainable by carefully crafting its strategy on contours of growth with financial stability in mind.

Srikanth is Associate Professor and Director (Finance), DDU-GKY, National Institute of Rural Development and Panchayati Raj, Hyderabad, and Prasad is a former Assistant General Manager, State Bank of India. Views are personal

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