The creeping concern over India’s public debt


The Supreme Court later directed the Centre to formulate guidelines for providing compensation under the Disaster Management Act.

High cost of out-of-pocket health spending and large-scale job losses during the two waves of the pandemic have pushed millions of families across India into poverty and high indebtedness. But Mehta’s arguments underline the government’s limitations, the precarious revenue situation amid growing demand for resources and uncertainty about the impact of future waves of the pandemic.

The numbers certainly don’t look pretty.

The economic contraction—3% in nominal gross domestic product (GDP)—and 7.7% decline in revenue receipts in 2020-21 has forced the government to borrow a record amount to meet a revenue shortfall. Thereby, the Union government’s debt soared to 58.8% of the gross domestic product (GDP) in 2020-21, a 14 year high. A year ago, the debt-to-GDP ratio was 51.6%. General government debt, combining debt of both the Centre and states, is projected to cross 90% of GDP in 2020-21 from 74.1% the year before.

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Debt burden

This explains why the government has refrained from announcing big-ticket fiscal stimulus such as cash transfers to those impacted by the pandemic. During the second wave, the government has primarily focused on credit guarantees and liquidity support to distressed sectors apart from free foodgrains for 800 million Indians till November, mimicking its support programme of last year.

Even then, the high public debt is worrying rating agencies who also question the cost of servicing it. There are palpable fears around a ratings downgrade, which has both direct and indirect effects on the economy. The Indian government, on its part, feels the worries are over blown. But more of this later.

Fiscal conservatism

The government’s unwillingness to provide any meaningful income support also stems from its ideological opposition to large scale ‘wasteful’ revenue expenditure. In other words, the government is fiscally conservative.

Indian economy has been on a downward spiral since 2016-17 when the government-imposed demonetization of high value currencies and subsequently implemented a faulty Goods and Services Tax (GST). Now, facing a once-in-a-century pandemic, the government chose more supply-side interventions than providing a strong fiscal stimulus to revive consumer sentiment and demand. While the 2021-22 budget admittedly factored in a capex-led stimulus, the government’s reluctance to go for a big-bang demand push could be attributed to fiscal conservatism and fear of a downgrade by the credit rating agencies, given the mounting debt burden.

In an interview with Mint, chief economic adviser to the finance ministry Krishnamurthy Subramanian said the problem with unconditional transfer like the 85,000 crore “disastrous” farm loan waiver of 2009 was that there was very little impact on consumption. Hence, the fiscal multiplier was also almost non-existent because it was cornered by people who didn’t need it. “That kind of spending, that too revenue expenditure, which does not generate multipliers for the economy, is a waste of taxpayers’ money,” he held.

The large stimulus provided by the Manmohan Singh government after the global financial crisis along with the farmers’ loan waiver, led to a massive jump in fiscal deficit, from 2.54% of the GDP in 2007-08 to 6% in 2008-09 and subsequently to 6.5% in 2009-10. The Narendra Modi government has often chided the Congress party for its “fiscal adventurism” that did not create any long-term assets in the country.

In contrast, all the schemes that the incumbent government has implemented for supporting the distressed have been well thought out and directed, Subramanian said. One example is the credit guarantee scheme for microfinance institutions (MFIs) for on-lending to the urban poor.

“MFIs touch almost 2 crore people in urban and semi-urban areas. When a borrower that is genuinely distressed doesn’t repay and the government guarantees that, this is effectively a quasi-cash transfer and ends up going to those that are genuinely distressed,” he said.

Subramanian’s colleague, principal economic adviser to the finance ministry Sanjeev Sanyal, had last year admitted that the present government is a “fiscally conservative” one and that it believes in sticking to a fiscal trajectory. Sanyal, however, said India’s debt-to-GDP ratio is much lower than that of many countries and hence there is a case for allowing that to go up for doing things that will reflate demand.

Rating fears

India’s public debt-to-GDP ratio is indeed lower compared to many developed and developing countries. However, rating agencies view it differently—they consider the ratio to be well above India’s peers in a similar rating category.

Global government debt hit an all-time high in 2020 increasing to 97.3% of global GDP from 83.7% before the pandemic. Public debt-to-GDP ratio of advanced countries rose by 16 percentage points to 120.1% and that of emerging markets by almost 10 percentage points to 64.4% in 2020, according to the International Monetary Fund.

Andrew Wood, director at S&P Global Ratings, said that though debt levels have risen in many countries around the world, India’s net general government indebtedness is notably higher than sovereigns with economies at a comparable stage of development. “In order for the general government’s net indebtedness level to stabilize and decline, India would likely require consistently strong nominal GDP growth, and progressively smaller fiscal deficits. As such, economic growth and fiscal deficit trends will both be important factors in determining India’s credit ratings,” he said.

S&P, on 14 July, reaffirmed India’s sovereign rating at the lowest investment grade (BBB-) with stable outlook. The other two key rating agencies, Fitch and Moody’s, have lowest investment-grade sovereign rating for India with negative outlook.

William Foster, vice president at Moody’s Investors Service said that over the medium term, prospects for India’s debt burden to decline have diminished. “Under average nominal GDP growth of around 11.5%, which we project as the baseline for the four years through the fiscal year ending March 2025, we expect debt to stabilize at around 92% of GDP,” he added.

India has always held that its current sovereign rating does not reflect the true potential of the economy. Despite its stellar growth performance in recent decades, the credit rating hasn’t improved.

In a chapter titled “Does India’s sovereign credit rating reflect its fundamentals? No!”, the latest Economic Survey admitted that despite ratings not reflecting fundamentals, pro-cyclical action by rating agencies can affect equity and debt foreign portfolio investor (FPI) outflows from developing countries, causing damage and worsening crisis. Experts believe that there is fear within policy mandarins in India on the impact of a rating downgrade from its current lowest investment grade, which could throw India into junk status.

S&P, in its latest rating action, cautioned that it may lower the ratings if India’s economy recovers significantly slower than it expects from 2021-22 onwards, or net general government deficits and the associated accumulation of indebtedness materially exceed its forecasts. It may raise the rating if India’s economy exhibits a stronger recovery than it expects over the next 24 months.

The consequence of a further downgrade is overrated, some believe.

Former chief statistician of India Pronab Sen said people often forget that India was below investment grade well into the first decade of 21st century. “A rating downgrade could well happen. But it will impact mostly the small foreign investors who may withdraw their money. Large investors depend on their own research and don’t rely only on input from credit rating agencies and are unlikely to be impacted by a rating downgrade,” he added.

In the 1990s and mid-2000s, India’s sovereign credit rating was “speculative grade”. India’s credit rating was upgraded to investment grade by Moody’s in 2004, Fitch in 2006 and S&P in 2007. Notably, the Indian economy grew at an average rate of over 6%, and at approximately 8% for several years during this period. India’s high rate of economic growth therefore co-existed with the speculative credit rating. The concern, then, is beyond an economic impact—no government can afford the political fallout of a junk status.

Debt servicing worries

Meanwhile, it is not just high public debt that worries rating agencies. The rising cost of debt financing is even more concerning for some. A spike in interest rate in India could soar debt financing cost of the government. In 2021-22, out of every 1 expenditure of the Centre, 20 paise (20%) will go to interest payment for accumulated public debt, the highest expenditure head in the Indian budget. For a low middle-income country like India, that is too heavy a burden.

Wood said that high public debt can entail higher debt servicing requirement, which undermines the proportion of revenue that the government can allocate to social spending. “We estimate that the Indian general government will spend just over 30% of its revenues on interest costs alone,” he added.

Foster sees interest payments reaching about 28% of general government revenue in 2021, the highest among peers.

However, Subramanian points out a flaw. “There is conceptual error when you only look at it from debt servicing cost. Debt sustainability depends on ‘r-g (interest rate-GDP growth)’ differential. As long as it is negative, you have debt sustainability,” he added. The belief: in the years ahead, India’s GDP can grow faster than the accrual rate of debt, which overtime would lower the relative cost of servicing it.

Meanwhile, both experts and multilateral organizations are warning against an early withdrawal of fiscal support.

The World Bank, in its latest report, Global Economic Prospects, said that many emerging market and developing economies will need to be careful to avoid a premature withdrawal of fiscal support, while still keeping a steady eye on medium-term debt sustainability. “Given the historic increase in sovereign debt, it will be essential to improve the efficiency of public spending. Strengthening domestic revenue mobilization and medium-term fiscal frameworks can help widen fiscal space and bolster policy credibility,” it added.

Pronab Sen said the government’s plan to have a medium-term fiscal consolidation roadmap as recommended by the 15th Finance Commission to bring down debt-to-GDP ratio should be junked until covid is no longer a threat. “Any effort to make that correction when GDP growth is low would mean the brunt of the adjustment will be on expenditure. Then you will be making a demand-side contraction and the GDP growth will start falling further. It will lead to an unstable situation,” he cautioned.

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