Budget 2022: Bringing Public Debt Down Requires A Strong Growth Path

The Covid-19 crisis has led to a ballooning of government debt across nations. India is no exception. While financial markets have been forgiving of higher debt, rating agencies and investors are watchful of the path to bring debt back to a sustainable path, particularly for emerging markets.

India's debt-to-GDP ratio rose to 87.8% in FY21. In FY22, it is estimated to decline modestly to 87.4%, with high nominal growth playing a role in bringing it down.

"Our forecast is that high nominal GDP growth and a narrowing of the fiscal deficit will bring the debt down to 87.4% in FY22 and 85.9% in FY23," Jeremy Zook, director for Asia Sovereign Ratings at Fitch Ratings, told BloombergQuint over email.

The rating agency, which reaffirmed its rating for India at 'BBB-' with a negative outlook in November 2021, cited higher public debt as a factor behind its outlook. "Higher debt levels constrain the government's ability to respond to shocks and could lead to a crowding out of financing for the private sector," the rating agency had said then.

During the pandemic, government debt ratios rose in nearly every sovereign globally, as governments provided fiscal support to counter the pandemic, Zook said. The median ‘BBB’ debt ratio jumped from about 42% of GDP in 2019 to 60% in 2021, though it is expected to decline to 55% in 2022.

Ironically, bringing down the country's debt-to-GDP ratio may require the government to follow a more calibrated fiscal consolidation path, to ensure growth remains strong over the next few years.

According to an August 2021 paper by Sajjid Z.Chinoy and Toshi Jain, India economists at J.P. Morgan, if India’s nominal GDP were to average about 10% over the coming years—corresponding to real GDP growth of 6.5-7%, the debt-to-GDP ratio will stabilise even allowing for a more gradual pace of fiscal consolidation.

Quicker fiscal consolidation, in turn, may hurt growth and leave debt levels higher for longer.

"India’s debt/GDP will rise to between 85-90% at the end of this year, and preserving debt sustainability will be the key," said Chinoy in another report earlier this month. But this will involve a fine balance between reducing the primary deficit without choking the recovery, he said.

A study on growth and debt sustainability in the Economic Survey of 2021 also said that higher growth is key to easing the public debt burden.

The ease with which a government can reduce its debt-to-GDP ratio depends primarily on the interest rate-growth differential, said the Survey, adding that higher growth is the key to sustainability of debt for India. A negative interest rate-growth balance will continue to create an enabling environment for debt sustainability, it added.

But the balance will be a fine one to strike, as lack of fiscal consolidation could push up interest rates.

The government has to do a balancing act between addressing the requirements of an economy that could potentially be hit by a new variant of Covid-19 and the imperatives of macro-stabilisation, said Radhika Pandey, senior fellow at NIPFP. However, if the third wave is not as severe as the second wave, the government should revive its focus on fiscal consolidation, she added.

To be sure, the central government's fiscal policies alone won't help in bringing down public debt to more sustainable levels.

State government liabilities are at over 33% of GDP, adding to the consolidated debt levels. The rise here has been steeper and has led the increase in general government debt, the RBI noted in a paper published in 2020. For the states, debt is increasing at a double-digit rate, at a pace higher than nominal GDP growth, the RBI working paper on sub-national government debt sustainability said.

The study found that after the implementation of the UDAY scheme, states’ debt recorded a sharp increase in FY16 and FY17 to around 25% of GDP. The states curtailed capital expenditure to meet fiscal targets amidst the rise in revenue expenditures, thus deteriorating the quality of the expenditure, the paper added.

Higher public debt can be harmful for government finances due to a higher interest burden. It can also lead to a crowding out of private borrowings. Of the two, the former may be a more notable constraint at this juncture.

Interest expenses rose to constitute 44.6% as a share of revenue receipts, according to revised estimates for FY21. A rising interest burden could squeeze the space for capital expenditure which is needed at this time, said Pandey.

However, fear over high government borrowings crowding out private investment is limited as overall investment demand is very low, said R Nagraj, visiting professor at the Centre for Development Studies.

Given that India's economic growth has slowed significantly for over seven years, and the fixed investment-to-GDP ratio has decelerated at an unprecedented rate during this period, there is an urgent need to boost public investment to stimulate investment demand and pull-in private investment, Nagraj said.

The government is fully cognizant of the need to maintain a tight fiscal plan, it said in its medium term fiscal policy statement accompanying last year's budget. However, a need for a higher public spending is felt crucial for providing required impetus to economic growth, it added.