Economic Survey's optimism about India's public debt looks misplaced

The Economic Survey 2020-21 has asked the government to raise public spending in the upcoming Budget without the fear of higher fiscal deficit and debt sustainability.

India will not face the problem of debt sustainability even in the worst of scenarios till 2030, the Survey observed.

Chief Economic Advisor Krishnamurthy Subramanian noted in the Survey that in fast-growing emerging economies, rapid growth in gross domestic product (GDP) translates into lower debt-to-GDP ratios, but lower debt does not necessarily lead to higher growth.

The Survey’s optimism about India’s public debt looks misplaced. India entered the pandemic with one of the highest public debt-to-GDP in the emerging market (EM). The ratio is expected to reach a record high of 90 per cent by the end of March this year, according to the data from the International Monetary Fund (IMF).

The ratio was 72.3 per cent in 2019 and 68.8 per cent five years ago in 2015, according to the data from IMF’s World Economic Outlook.

This makes India the third most indebted economy in the EMs, after Brazil and Argentina. In South Asia, India now becomes the third most indebted country, after Bhutan and Sri Lanka, but worse off than Bangladesh, Pakistan, and Nepal.

Interest payment in public debt is now the fastest-growing revenue expense for the government.

According to the Budget Estimates, interest payment was expected to rise 13.3 per cent in 2020-21 (FY21), against total central government expenditure of 12.7 per cent.

Interest payment was budgeted to account for nearly a quarter of the government’s total expenditure in FY21. The actual numbers could be higher, given a combination of lower tax revenue and additional borrowing during the current fiscal so far due to Covid-19.

According to estimates by economists, additional borrowing in FY21 could add up to Rs 1.5 trillion to the annual interest bill.

The additional interest burden is equivalent to nearly 5 per cent of all tax revenue and around 10 per cent of central government net tax revenue.

This may greatly limit the government’s ability to raise borrowings further in 2021-22 to fund a large fiscal stimulus.

Another headache for the government is the downward drift in India’s GDP growth that has led to lower buoyancy in tax revenue.

“Once growth picks up in a sustainable manner, it will be time for fiscal consolidation. For now, fiscal policy will have to remain centre stage to support growth in the foreseeable future,” it added.

The five-year forward interest rate for all maturities have been trending downwards, and it is less than 7.5 per cent for the 10-year bond rate. With an average inflation of 4 per cent and a real GDP growth rate of as low as 3.4 per cent, dangers to debt sustainability will be minimised.

To understand debt sustainability, consider the government debt as numerator, and India’s nominal GDP as denominator. If the denominator increases fast (higher GDP growth), debt-to-GDP ratio falls rapidly.

The Survey underlines the importance of ‘interest rate growth-rate differential’ (IRGD), which is the difference between the interest rate and growth rate in an economy. It is not much due to lower interest rates (R), but more due to higher growth rates (G), that India’s debt sustainability is less of a worry.

Emerging economies like India, China, Russia, and South Africa have had negative IRGD in the past three decades, the Survey shows.