Why pruning general debt to 66% of GDP over next 5 years looks unachievable

An RBI report says even in the best case scenario, general govt debt may not dip below 75% of GDPl and if there are events, it may in fact rise to 90% of GDP by 2026-27

While a recent Reserve Bank of India report wants the Central and state governments to reduce their debt to 66 per cent over the next five years from the current level of about 90 per cent to put India on a sustainable growth trajectory, the task remains daunting.

The report on Currency and Finance says,"... growth is at risk once general government debt exceeds a threshold of 66 per cent of GDP...  A medium term strategy of debt consolidation aimed at reducing debt to below 66 per cent of GDP over the next five years is, therefore, important to secure India’s medium-term growth prospects," it says.

The report adds that with monetary policy prioritising price stability and pursuing output stabilisation in an environment in which debt sustainability is sought to be achieved by fiscal prudence, the assignment rule is satisfied,

bringing in its train macroeconomic stability to support sustainable growth.

As such, debt has to be managed by fiscal policy.

Icra chief economist Aditi Nayar said, "While revenues such as GST and central tax devolution have performed well last year, the end to GST compensation will pose a structural challenge to some states. Given the importance of state governments hastening capital spending, the focus on debt consolidation may have to take a back seat in the next year or two."

Bank of Baroda chief economist Madan Sabnavis said general debt could be reduced to 66 per cent of GDP if two conditions are satisfied-- first, GDP growth must be in acceleration mode with nominal GDP growth clocking 13-14 per cent a year on a sustained basis. This will also help reach the $5 trillion economy mark swiftly. Second, debt must be controlled for which fiscal deficit has to be controlled and brought down to three per cent of GDP in the next three years.

"Now for the second part there are issues--the government is still the driver of investment and food and fertiliser subsidies to support the weaker sections are still high," he said.

As such, expenditure control will be the key, and will happen when the world economy normalises, Sabnavis said, adding  that revenue buoyancy will automatically take place once GDP growth is on track.

"Therefore to my mind this is achievable, though it could be touch-and-go. (It) can take a little more than five years depending on how soon we get back to the three per cent goal," he said.

Further, Sabnavis said he does not think governments can plan on debt ratio. They can work on the fiscal deficit ratio and as this is achieved, the debt ratio will be affected, he explained.

In fact, the RBI report also considered this path to be daunting.

"Reducing debt to more sustainable levels that are (also) compatible with the growth trajectory being envisaged for a post pandemic Indian economy will be daunting," it said.

Even under the best possible macroeconomic outcomes, general government debt may not decline below 75 per cent of GDP over the next five years, it said, adding that if there are adverse events, it may in fact rise to 90 per cent of GDP by 2026-27.

The report calls for focus on tax receipts to reduce debt levels. It says, "Beyond innovative financing options and re-orientation of expenditure towards capex to benefit from higher multiplier effects, rationalisation of expenditure and raising the country’s tax-to-GDP ratio may have to be an integral part of the fiscal rebalancing act post-Covid."

The general government debt (of the Centre and the states) reached the peak of almost 90 per cent of GDP in 2020-21 as the governments struggled to support vulnerable sections from the effect of Covid-induced lockdowns and spur the economy as private investments took a beating.

Debt is projected to have touched almost 85 per cent of GDP during 2021-22 when the economy faced another devastating wave and, later, one more mild wave. This year, debt is expected to be a bit over 84.3 per cent, but may turn out to be higher if the Russia-Ukraine war prolongs.

General sovereign debt touched almost 70 per cent of GDP and crossed it in and after 2017-18, and the economy started slowing down. It crossed 75 per cent even in the pre-Covid period of 2019-20 when the economic growth decelerated and could not touch even 4 per cent.

The effect of rising debt in recent years would be felt over a decade later when government bonds come up for redemption. However, even now the interest burden on the exchequer is quite high. It has been about 40 per cent of revenue receipts so far as the Centre is concerned for the past three years. These, of course, include revised estimates for 2021-22 and 2022-23. The states' interest payments were also in the range of 13-14 per cent in recent years.

That's why the RBI report calls for the reduction of general government debt to 66 per cent over the next five years. However, this is easier said than done. 

Table: India's general debt has been steadily rising since 2016-17

Year	Combined debt of Centre and states as % of GDP	Interest payments:revenue receipts ratio in %		GDP growth in % YoY
		Centre	States
2016-17	68.77	35	12.2	8.3
2017-18	69.8	36.9	12.8	6.8
2018-19	70.78	37.5	12.2	6.5
2019-20	75.7	36.3	13.2	3.7
2020-21	89.4	41.6	14.1	-6.6
2021-22	85.2*	39.1**	.	8.9
2022-23	84.3*	42.8#	.	.

Note: * Projections by RBI paper on Currency and Finance; ** Revised estimates, # Budget estimates