National Council of Applied Economic Research
Opinion: Poonam Gupta and Barry Eichengreen
India was an outlier on fiscal outcomes pre-pandemic, and it drifted further in the high-debt direction during COVID. At their peak in 2020-21, the public debt and fiscal deficit of the General Government (the Centre and the States together) stood at 89 per cent and 13 per cent of GDP, respectively. With the recovery of nominal GDP, these ratios have fallen. But at 84 per cent and 9 per cent, they are still high relative to other emerging market and middle-income countries, where they average 60 per cent and 5 per cent, respectively.
Even if high, India’s public debt is not unsustainable as per the standard metrics.
A first criterion for sustainability is whether there is a significant rollover risk, where government suddenly finds it impossible to replace maturing debt at any price. A captive market for public debt among banks, insurance companies and provident funds, together with high household savings, have enabled the government to fund its deficits without undue pressure on borrowing costs. The currency composition and maturity of the debt further limits rollover risk. Nearly 90 per cent of the General Government debt is long-term. The average maturity periods for both Central and State government loans have been increasing, contributing to its stability.
In 2000-01, about 13.5 per cent of the Central Government debt was issued externally. Since then, there has been a steady decline in the share of external debt, which stood at just 3.7 per cent in 2021-22. Most external debt is concessional and owed to multilateral and bilateral lenders. Holdings of foreign institutional investors are just 1 per cent of the total debt, and foreign banks hold negligible quantities of Indian government debt. Debt denominated in foreign currency is just 4 per cent of the total. State Governments do not issue external debt. Consequently, the overall debt portfolio is largely insulated from currency risk.
A second criterion for sustainability is whether the debt ratio will remain stable. This will be the case, assuming that the primary budget deficit, GDP growth rate, and real interest rate will remain at the same level in the coming years as their respective averages over the last decade.
But whereas the debt ratio of the Central Government remains stable in our baseline scenario, that of the States shows a tendency to rise. There is considerable heterogeneity in the fiscal position of different States, with certain problem cases contributing disproportionately to the level and rise in the aggregate State debt-to-GDP ratio. Such States incur higher primary deficit and higher contingent liabilities.
Despite our assessment of sustainability, there are nonetheless significant costs and risks associated with India’s high debt and deficits.
First, interest payments absorb resources, limiting their availability for other economic and social purposes. Interest payments already exceed 25 per cent of general government revenues, which is twice the emerging market and developing-country average.
Second, absorbing fiscal resources in this way leaves no room for meeting emerging priorities, notably climate change abatement and adaptation, and the green transition.
Third, debt dynamics leave little room for responding to shocks, such as declining rates of domestic and global growth.
Fourth, high government debt creates the potential for financial stability risks. Banks are required to hold government securities in order to satisfy their Statutory Liquidity Ratios. Risks to their balance sheets can develop with the re-pricing of these assets when interest rates rise. For the moment, India is able to place most of its debt with “patient” domestic investors. But if this changes, going forward, risks will increase.
While India’s general-government-debt-to-GDP ratio may not increase further, it is unlikely to decline rapidly either. In our best-case scenario, assuming an acceleration of real GDP growth to about 8 per cent and a lower primary deficit of 2 per cent of GDP, the ratio will fall from its current level of some 90 per cent of GDP to only some 80 per cent of GDP.
This best case scenario is unlikely to materialize. Smaller primary budget deficits will be difficult to achieve, given the pressure for social and infrastructure spending and the difficulty of boosting tax revenues. Accelerating growth will be challenging, especially in the current global environment.
Progress is needed on a combination of fronts.
First, India’s deficit is more a problem of low revenue than high expenditure. The revenue-to-GDP ratio is below that of most other emerging markets and has seen the slowest rates of increase over the last 20 years. The public-expenditure-to-GDP ratio, in contrast, is not atypical. This gap has resulted in a perennially large budget deficit as compared to other emerging markets. Raising additional revenue through higher tax, non-tax, and privatization receipts is, therefore, of utmost importance.
Along with better tax administration and digitalization, recent tax reforms have succeeded in modestly boosting revenue growth. More could be done both through additional digitization and administrative streamlining, and through the adoption and better administration of taxes at the State or local level, such as the property tax.
Second, continuing to re-orient spending toward capacity- and infrastructure-enhancing investment has the potential to boost GDP and revenues.
Finally, limiting contingent liabilities, which have posed a chronic problem at the State level, would help anchor the debt of the States.
In sum, India’s high public debt leaves no room for mis-steps.