IMF’s January 2021 Fiscal Monitor Update revealed that global public debt has risen to 98 per cent of GDP (higher by 14 percentage points from the same report, October 2019), primarily due to additional spending, forgone revenue and liquidity support. Comparing among group countries, the ratio for advanced, emerging and middle income, and low income developing countries are respectively, 123 per cent, 63.3 per cent and 48.5 per cent of their GDP as against pre pandemic levels of 105.2 per cent, 54.2 per cent and 43 per cent.
The public debt to GDP ratio, a measure of government debt sustainability, is a function of government’s outstanding debts, primary deficit (fiscal deficit excluding interest payments) and interest rate growth differential. The lower the ratio, the healthier is the government’s finances since it reflects public debt’s potential to create higher value, in terms of GDP, and hence generate higher revenues which will enable the government to repay its liabilities. Debt sustainability, therefore, becomes an important metric to evaluate a country’s sovereign risk.
In emerging high growth economies such as India, the government is required to propel growth through sufficient fund allocation in infrastructure and other essential resources. With additional burden of the pandemic and existing human capital issues such as poverty, malnutrition and illiteracy, the need for the government to spend on welfare is an added burden. Hence, large amounts of borrowings are needed to fill the revenue – expenditure gap.
Year after year, such borrowings build on government’s outstanding debt adding to another indispensable expense in the form of interest payments. In India too, the public debt ratio has increased to 89 per cent from pre pandemic level of 72%. The current level is higher as per the target set by the latest amendment of FRBM act, 2003. Rise in primary deficit and deterioration in interest rate growth differential, since 2019, have further fueled skepticism on the debt sustainability of India. This may be considered laxity in fiscal discipline under normal circumstances. Is this laxity really alarming when the economy is in unequivocal need of the support, is the moot question to ask.
In the past decade, the central government’s fiscal deficit, as a percent of GDP, had fallen till financial year (FY) 2019. In FY 2020, it increased primarily due to slowdown, evolving processes in GST collections and corporate tax rate cut. Later, it deteriorated further on account of the pandemic induced recession. A similar trend is observed for the general government’s fiscal and revenue deficits. The interest payment too, increased in absolute terms even though it decreased, as a percent of GDP, since the taper tantrum of 2013.
The taper tantrum event was caused in anticipation of sudden reversal of accommodative policy which was adopted by the United States and other advanced economies since the Global Financial Crisis. It resulted in substantial market volatility due to indiscriminate foreign capital outflow from emerging economies. India too, was affected and had responded with swift and temporary actions to minimize the disruption.
Later, a series of reforms including current flexible inflation targeting regime, were introduced to enhance depth and efficiency of institutions and markets. It helped in strengthening system resilience to deal with vulnerabilities caused by external shocks like the recent events of rise in global government bond yields.
These reforms have also yielded lower inflation expectations and hence lower expected interest rate in medium to long terms. The government’s perceived intent to tackle food inflation through increased infrastructure spending and other structural reforms will also play a role in taming inflation expectations.
The recent union budget projected an increase in interest payments as a percent of GDP but relatively lower than that of the fiscal deficit. Any change in future interest payment depends mainly on vulnerabilities due to external shocks, inflation management and medium term domestic growth dynamics.
The latest GDP estimates released by the ministry of statistics and programme implementation have highlighted positive growth of 0.4 per cent for Q3, FY 2021, better than previous projections. For Q1 and Q2, the growth rate revised to -24.4 per cent and -7.3 per cent respectively as against -23.9 per cent and -7.5 per cent from previous estimates.
A similar improvement (except for Q1, FY 2021) is observed in growth estimates from other sources such as RBI, IMF, World Bank etc. Even though these positive growth projections emerge from strong base effects, the government’s focus on capital spending, infrastructure development, health, innovation and research will further supplement the medium term growth prospects.
These developments will positively impact the interest rate-growth differential and take care of debt sustainability in future. Hence, policy support, with judicious resource allocation towards sustainable long-term growth, should be continued.
(Preeta George is Professor of Economics and Jaya Bhargavi, Research Associate at Bhavan’s SPJIMR.)