Three ways to deal with the high govt debt

Subject: Economy

Section: External Sector

Context:

The Narendra Modi-headed National Democratic Alliance (NDA) government will end its second term with overall public debt in excess of 80% of India’s gross domestic product (GDP) at current market prices.

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According to International Monetary Fund (IMF) data, general government debt – the combined domestic and external liabilities of both the Centre and the states – touched 84.4% of GDP in 2003-04.
That ratio fell to a low of 66.4% in 2010-11.
It rose gradually to 7% in 2013-14 and 70.4% in 2018-19.
The present government’s second innings saw the debt-GDP ratio soar to 75% in 2019-20 and peak at 88.5% in 2020-21, before easing to 83.8% and 81% in the following two fiscal years (April-March).
The IMF has projected the ratio at 82% in the current fiscal and 4% for 2024-25, which is still close to the high levels of the early 2000s.
General government debt climbed from 7% of GDP in 2019 to 133.5% in 2020 and 121.4% in 2022 for the US; from 97.4% to 115.1% and 111.7% for France; from 85.5% to 105.6% and 101.4% for the United Kingdom; and from 60.4% to 70.1% and 77.1% for China during these years.

What public debt entails:

Government debt is basically the outstanding domestic and foreign loans raised by the Centre and states.
It includes other liabilities, including against small savings schemes, provident funds and special securities issued to the Food Corporation of India, fertilizer firms and oil marketing companies – on which they have to pay interest and the principal amounts borrowed.
As per the Fiscal Responsibility and Budget Management (FRBM) law 2003, the general government debt was supposed to be brought down to 60% of GDP by 2024-25.
The Centre’s own total outstanding liabilities were not to exceed 40% within that time schedule.
In absolute terms, the Centre’s total liabilities have more than doubled from Rs 90.84 lakh crore to Rs 183.67 lakh crore between 2018-19 and 2024-25.
There is a decline in the interest-to-GDP ratio from a high of 4.7% in 2002-03 to 3.1% by 2010-11.
The ratio more or less stabilized at 3-3.1% till 2019-20, before surging to 3.4% in 2020-21 and 3.6% in the current and ensuing fiscal

Why has debt spiralled?

The most obvious reason is the Covid-induced disruptions that forced governments to borrow more in order to fund additional public health and social safety net expenditure requirements.
The combined gross fiscal deficit of the Centre and the states i.e. the gap between their total spending and revenue receipts went up from 8% and 7.2% of GDP in 2018-19 and 2019-20 respectively, to 13.1% and 10.4% in the next two fiscals.
The Centre’s fiscal deficit alone increased from 4% of GDP in 2018-19 to 4.6% in 2019-20, 9.2% in 2020-21 and 6.8% in 2021-22.
The present government, apart from spending more on income and consumption support schemes, also stepped-up public investments in roads, railways and other infrastructure.
The Centre’s capital expenditure has dropped from 3.9% to 1.5% of GDP between 2003-04 and 2017-18.
It revived significantly thereafter to reach2% in 2023-24 and 3.4% in the Interim Budget for 2024-25.

How can debt be reined in?

The FRBM Act envisaged limiting the Centre’s gross fiscal deficit to 3% of GDP by 2020-21.
The present government has opted for a new broad “glide path” of fiscal consolidation.
As per Union Budget speech 2021-22 which aims to attain a fiscal deficit-to-GDP ratio of “below 4.5%” by 2025-26.
While fiscal consolidation can ensure a check on borrowings and not too much being added to the stock of government debt relative to GDP – the IMF has warned against crossing the 100% mark.
There are two other routes as well for bringing the latter down.
That would involve what one may call the denominator effect.
Government debt and fiscal deficits are usually quoted as ratios to GDP at current market prices.
High nominal GDP growth where the denominator rises faster than the numerator helps in some way in solving the government’s debt problem.
GDP growth, in turn, can come from both real output increases and inflation.
The second and third way to drive down the government debt-to-GDP ratio is to “grow” or “inflate” it away.
This actually happened during 2003-04 to 2010-11 when general government debt plunged from 84.4% to 66.4% of GDP.
However, this period incidentally, also witnessed an average annual GDP growth of 7.4% in real and 15%-plus in nominal terms after adding inflation.