The Debt Dilemma
Context:
The article focuses on fiscal deficit and public debt in India. It highlights the elevated levels of fiscal deficit and public debt, which have been a cause of concern even before the COVID-19 pandemic.
Relevance:
GS-02 (Government Policies and Intervention)
Gs-03 (Fiscal Policy)
Prelims:
- Fiscal Policy
- GST
Mains Questions:
- Explain the concept of “financial repression” and its implications on India’s fiscal deficit and public debt. (150 words)
Dimensions of the Article:
- A Closer Look at India’s Fiscal Deficit and Public Debt
- The Perplexities of Debt Sustainability and Financial Repression
- Consequences of High Deficits and Debt
- Navigating the Debt Burden
A Closer Look at India’s Fiscal Deficit and Public Debt
- India has been grappling with elevated levels of fiscal deficit and public debt, which have raised concerns both domestically and internationally. Even prior to the COVID-19 pandemic, the nation’s debt levels ranked among the highest in developing economies and emerging markets.
- With the pandemic exacerbating the situation, the fiscal deficit relative to GDP reached a staggering 13.3% in 2020-21, while the aggregate public debt soared to 89.6%. Though the economy showed signs of recovery, the deficit and debt ratios have remained substantial at 8.9% and 85.7%, respectively.
The Perplexities of Debt Sustainability and Financial Repression
- Addressing the growing debt burden requires a deeper examination of key factors such as financial repression. The debt-dynamics equation, often cited in discussions, suggests that when the growth rate of GDP surpasses the effective interest rate on government bonds, the overall debt should decline in the absence of a primary deficit.
- However, this equation tends to overlook the distortions induced by financial repression aimed at artificially keeping interest rates low for reducing borrowing costs. The Reserve Bank of India’s (RBI) stipulated Statutory Liquidity Ratio (SLR) compelling banks to hold a significant portion of their demand and time liabilities in government securities is a prime example of such measures.
- Additionally, RBI intervenes in the market through open market operations when government borrowing is initiated, further contributing to interest rate repression. As a consequence, even if the debt may decline in the medium term, these financial manipulations create distortions in the debt market.
Consequences of High Deficits and Debt
- The ramifications of high deficits and debt are multifaceted and demand immediate attention.
- Firstly, the substantial interest payments, constituting over 5% of GDP and 25% of revenue receipts on average, present a significant challenge. These interest payments alone surpass government spending on essential sectors like education and healthcare combined. The scarcity of funds impedes investments in critical physical infrastructure, human development, and emerging areas like the green transition, raising concerns in states like Punjab, Kerala, Rajasthan, and West Bengal, where debt-to-GSDP ratios are notably high.
- Secondly, elevated debt levels pose obstacles in effectively implementing counter-cyclical fiscal policies and limit the government’s capacity to respond swiftly to economic shocks.
- Thirdly, India’s debt market is predominantly captive, with commercial banks and insurance companies being the primary participants due to SLR requirements. The stringent reserve ratios and priority sector lending commitments further restrict lending to the manufacturing sector, consequently driving up borrowing costs for businesses. Moreover, higher deficits and debt ratings result in increased expenses for external commercial borrowing, creating a taxing situation for future generations.
Navigating the Debt Burden
- The trajectory of India’s fiscal environment reveals that achieving the 14th Finance Commission’s recommended consolidated debt-to-GDP ratio of 58.2 for 2019-20 seems unattainable in the medium term.
- The pandemic-induced economic disruptions pushed the aggregate public debt to alarming levels, leaving each citizen with a substantial debt burden of ₹1,64,000. As we strive to curtail this burden, expedited fiscal consolidation becomes an imperative need.
Way Forward:
- Encouragingly, the Goods and Services Tax (GST) has stabilized and exhibits considerable growth potential. Leveraging technological advancements in tax administration and compliance, it is projected to enhance the tax-GDP ratio by 1.5 to 2 percentage points in the medium term.
- Effecting policy interventions, it becomes paramount for the government to reassess its role, relinquishing activities that can be efficiently managed by the market.
- Disinvestment measures must be expedited, transferring non-strategic sectors to the private sector, while avoiding the pitfalls of pouring public funds into loss-making ventures.
- Similarly, at the state level, avoiding extravagant employment melas and largescale giveaways for electoral gains is crucial. Emphasizing cash transfers over commodity and service subsidies can better achieve redistribution objectives without distorting resource allocation.
