Elevated public debt in fiscal year 2021 matter of concern: Report

The fiscal position of the country has worsened due to the pandemic

As the fiscal position of the country worsens due to the pandemic, there are concerns over the elevated public debt and also higher fiscal deficit at 11.8 per cent in 2020-21, brokerage UBS Securities India said.

A report by UBS has also warned of a downgrade risk in the sovereign ratings by one of the three rating agencies in the next 12-18 months.

This is despite both the direct and indirect tax mop-up crossing the revised estimates for the year.

While net direct tax mop-up stood at Rs 9.45 lakh crore in 2020-21, which is almost 5 per cent more than the revised estimate, indirect tax collection jumped over 12 per cent to Rs 10.71 lakh crore, even as goods and services tax mop-up declined by 8 per cent.

"The fiscal position has deteriorated after the pandemic and now we estimate fiscal deficit widened to 11.8 per cent of GDP in FY21, up from 7.8 per cent in FY20," UBS Securities India chief economist Tanvee Gupta Jain said in the report.

She attributed this to the pandemic-related relief measures, credible and transparent accounting of subsidies (for instance, the food subsidy was shifted onto the budget from the Food Corporation's balance sheet), and a significant revenue shortfall.

However, the report expects fiscal deficit to narrow going forward but remain elevated at 10 per cent (the Centre's 6.5 per cent, states' at 3.5 per cent), helped by a cyclical economic recovery and the rollback of relief measures.

She noted that the elevated fiscal deficit has also led to historically high public debt levels, flagging concerns on the steep jump in the public debt in 2020-21.

As a percentage of GDP, the same has risen from 72 per cent in 2019-20 to a whopping 89 per cent in 2020-21 she said, adding nominal GDP must grow at least 10 per cent annually to help stabilise public debt levels at the current high levels before bringing it down.

The rise in the primary deficit, which is fiscal deficit less interest payments, and the deterioration in the interest rate growth differential has raised debt sustainability concerns.

UBS estimates indicate that even if the gap between the two series (interest rate and growth) turned positive for a brief period in 2020-21, it will normalise in 2021-22.

A better measure of debt sustainability is the interest expense-to-GDP. "If the central bank can keep policy rates lower for longer, we believe rising public sector debt could become associated with stable debt service costs, as maturing debt is refinanced at still historically-low rates," UBS said.

According to UBS, among emerging markets, India will have the third highest public debt to GDP ratio, after Argentina and Brazil, in 2021. The key to debt sustainability is the ability and speed with which the government can deliver on budget promises, specifically with regard to aggressive divestment and also higher public capex to help support nominal GDP growth, Gupta Jain said.

She also said in the medium term government will have to work towards moving along the fiscal consolidation path at a pace in sync with the pace of growth rather than sticking to a more relaxed path as laid out in the budget.

On whether the rising fiscal deficit and public debt are a threat to the sovereign ratings, UBS said compared to other high-debt emerging markets , India's public debt is largely domestic-funded and a significant share is held by local banks and the central bank, reducing the risk in a distress.

However, the wide fiscal deficit leaves little room to absorb further adverse shocks without compromising credit ratings, increases risks of the private sector being crowded out, and slows debt portfolio flows from abroad, she warned.

She added India is not an outlier in this and any lags in policy execution and implementation of growth-supportive reforms to boost sustainable growth could lead to widening macro stability risks.

"We do see a risk of a downgrade in the sovereign rating by one of the three rating agencies in the next 12-18 months," warned the report.