In economic literature, the traditional focus has been mostly on the debt sustainability based on Domar conditions, which lay emphasis on quantitative aspect of government debt: The necessary condition for sustainability is that growth rate of the country must exceed the interest rate. However, the problem with this condition is that the qualitative aspects of public debt are not given due weightage with different countries being clubbed together as having sustainable or unsustainable debt without analysing the composition of their debt. In fact, there is also a dearth of literature that focuses on the composition of debt while analysing the sustainability condition.
Countries make serious efforts to keep this ratio under control. However, it is not always the case that such high public debt to GDP (gross domestic product) ratio amounts to risk of sovereign default. For example, Japan has one of the highest debt-to-GDP ratios in the world (around 230 per cent of GDP in 2014). Japanese debt was never low but it has shown a sharp increase of around 30 per cent between 2010 and 2014. Yet, the country has not defaulted and its debt is still sustainable. However, there have been countries including Portugal, Italy, Greece and Spain (PIGS in 2011) and Argentina (2001) which have defaulted despite their overall sovereign debt being lower than Japan’s. How does one explain this?
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The answer lies in this academically less explored area. In the case of Japan, only five per cent of the sovereign debt is held by foreign investors with domestic investments including that from bank and postal savings, insurance and public pension funds and the Bank of Japan accounting for more than 80 per cent. However, for Greece, more than 70 per cent of its government debt was held by foreign investors at the time of default and they fled from the country because of an increase in global risk aversion. A country whose public debt is held majorly by internal players has clearly a more stable debt situation compared to that of a country where foreign players are the principle investors in government securities. Furthermore, if we look at the external debt position, we find that countries that have higher external debt are more prone to defaults.
For India, public debt is mostly internal. As a conscious strategy, issuance of external debt (denominated in foreign currency) is kept very low in India. Overseas investors account for only four per cent in the total government bonds and the majority of the investment comes from scheduled commercial banks, insurance companies, RBI and provident funds (accounting for around 85 per cent). External debt is from multilateral agencies such as IDA, IBRD, ADB, etc., and a small proportion of external debt originates from official bilateral agencies. There is no borrowing from international private capital markets. Compared to its peers, India is relatively protected from an external debt trouble even though the government debt to GDP ratio for India has been relatively high at more than 60 per cent, though declining over the last decade. At present India’s debt situation is sustainable as also evidenced by an International Monetary Fund (IMF) study.
What does this mean for the FRBM committee? First, we believe this composition must be taken into consideration while arguing for the sustainability of debt. Second, we expect the committee to deliberate on state finances in detail. In particular, there must be a clear statement on off balance sheet liabilities for states, for example, the impact of the Ujwal Discom Assurance Yojana (UDAY). This is very important for transparency.
Third, while fiscal deficit is important, we believe it is better to target either revenue deficit/fiscal deficit or the primary deficit number (fiscal deficit net of interest payments). At 0.3 per cent of GDP budgeted in FY17, our endeavour is ideally to move towards a neutral level.
Given all this, will we strive for a fiscal deficit number or a range? If it’s a range, the fiscal purists will always argue that on a Rs 13-lakh crore revenue mobilisation target, it does not matter if we are to save say 0.3 per cent of GDP, because that adds to only Rs 30,000 crore. However, if we go by this argument, every number will look small (say disinvestment receipts)!
Given all this, our suggestion is that a fiscal range presents an ingenious solution. In a highly uncertain situation, the assumption of one number and one solution being sacrosanct appears unreasonable and needs a re-look. In lieu of this, the FRBM committee may actually look at the consolidated fiscal deficit range for the Centre and states combined. This may be the best solution under the prevailing circumstances!