Date: 09/02/2023

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization of resources, growth, development, and employment.

Key Phrases: Fiscal Deficit, Total Liabilities of the Union government, Consolidated General Government Debt, Ratio of Public Debt to GDP, Dated Government Securities (G-Secs), Treasury Bills (T-bills), Acceleration in Nominal GDP Growth

Why in News?

• The new Union budget presented by finance minister Nirmala Sitharaman last week has a credible plan to further reduce the fiscal deficit as a proportion of India’s gross domestic product (GDP).
• However, the fact that the ratio of public debt to GDP is expected to increase over the next financial year despite this fiscal correction did not get enough attention in its immediate aftermath.

Public Debt In India:

• Public debt in India includes the total liabilities of the Union government that have to be paid from the Consolidated Fund of India.
• Sometimes, the term is also used to refer to the overall liabilities of the central and state governments.
• However, the Union government clearly distinguishes its debt liabilities from those of the states. It calls the overall liabilities of both the Union government and state General Government Debt (GGD) or Consolidated General Government Debt.
• The Union government describes those liabilities as part of its public debt which is contracted against the Consolidated Fund of India. This is as per Article 292 of the Constitution.

Internal Public in India:

• Internal debt constitutes more than 93% of the overall public debt in India.
• Internal loans that make up the bulk of public debt are further divided into two broad categories – marketable and non-marketable debt.
  • Marketable Debt: Dated government securities (G-Secs) and treasury bills (T-bills) are issued through auctions and fall in the category of marketable debt.
  • Non-marketable debt: Intermediate treasury bills (with a maturity period of 14 days) issued to state governments and public sector banks, special securities issued to National Small Savings Fund (NSSF) are classified as non-marketable debt.

Sources Of Public Debt:

• Dated government securities or G-secs
• Treasury Bills or T-bills
• External Assistance
• Short-term borrowings
• Public Debt definition by Union Government

Implications Of High Public Debt Ratio:

• A high public debt ratio has three main implications for macro-economic policy over the medium term.
  • First, the interest costs of servicing this public debt leave the government with less money to spend on essential items such as infrastructure, the green transition, welfare programs, defense, and social security.
  • Second, the government’s ability to respond to the next shock is restricted when the public debt ratio is already high.
  • Third, the Reserve Bank of India’s ability to conduct an independent monetary policy to control inflation is compromised with a mountain of public debt on behalf of the government.
• Thus, the goal of fiscal policy over the rest of this decade should be to bring down the public debt ratio to more reasonable levels.
• As the pandemic threat has retreated and the economy has recovered, more attention needs to be paid to gradually bringing down the public debt ratio over the rest of this decade.

THREE PILLARS FOR REDUCING PUBLIC DEBT:

• The economics of public debt dynamics tells us that any strategy to reduce the burden of public debt needs to be built on three pillars:
  • One, an acceleration in nominal GDP growth can bring down the public debt ratio by ensuring that the denominator is growing faster than the numerator.
  • Two, the acceleration in nominal GDP growth needs to be seen in the context of the average borrowing costs of the government; the gap between the two (r-g) should be seen as an indication of how easily India can grow out of its public debt problem.
  • Three, fiscal policy will have to play a role by not just reducing the headline fiscal deficit, but more specifically the primary deficit, or the gap in the government budget once interest costs on existing public debt are removed.

Parameters Determining Public Debt:

• The trajectory of public debt over the next few years depends on the growth in economic output, inflation, interest rates and fiscal policy.
• The experience of the first decade of this century provides us with some useful context.
• The public debt ratio came down by around 17 percentage points between 2002-03 and 2010-11.
  • The first part saw a success because India had a spectacular growth acceleration that also led to a sharp fall in the primary deficit.
  • This ended once the impact of the North American financial crisis hit Indian shores. Growth began to slow down, while the fiscal situation deteriorated.
• Yet, the public debt ratio continued to drop because high inflation kept nominal GDP growth well above borrowing costs, though this same combination of fiscal profligacy plus high inflation led to a run on the rupee in mid-2013.

What needs to be done now?

• Nominal GDP growth in the coming years is likely to be in very low double digits, unless there is a structural shift in potential growth as well as inflation.
• The gap between interest rates and nominal GDP growth will also be modest. What this means is that these automatic drivers of lowering the public debt ratio cannot do the job on their own.
• The government needs to use fiscal policy to bring down the primary deficit in the coming years.

Conclusion:

• The International Monetary Fund has estimated in its recent report on the Indian economy that the primary deficit consistent with stabilizing the public debt ratio is 2.3% of GDP.
• Deputy chief economist of the Institute of International Finance, estimates that India’s projected primary deficit for the next financial year is 1 percentage point higher than what is needed for public debt stabilization, assuming real growth of 5.5%, inflation of 4%, and average borrowing costs of 6.5% in the medium term.
• India has managed its public finances well during these troubled few years, but the public debt ratio needs to get back to at least pre-pandemic levels to build more economic resilience for the years ahead.

Source: Live-Mint

Mains Question:

Q. Public debt ratio needs to get back to at least pre-pandemic levels to build more economic resilience for the years ahead. Discuss. (150 words).