Interest on public debt may eat away half of govt tax revenue in FY21, FY22

The fiscal headroom for the central government may shrink as interest on public debt is set to consume more than half of the government’s tax revenues this fiscal year as well as the next.

Expenditure on interest will account for 52.4 per cent of the central tax revenues in FY22 — the highest in 18 years and up from 37 per cent in FY20.

As a result, the ratio of tax revenue to expenditure on interest payment will decline to an 18-year low of 1.9x in FY22 from 2.7x in FY20 and 2.14x five years ago.

The Budget has projected 16.9 per cent year-on-year (YoY) growth in interest payments in FY22 against 14.9 per cent growth in central government tax revenues (net of state’s share in central taxes). The Centre is expected to spend around Rs 8.1 trillion on interest payments in FY22 against net tax revenues of around Rs 15.5 trillion.

A faster rise in expenditure on interest payment coupled with a record high public debt to gross domestic product (GDP) ratio also raised concern about the sustainability of India’s public debt.

The public debt to GDP ratio is expected to reach an all-time high of around 90 per cent at the end of March this year. This includes the outstanding debt of state governments and local bodies.

The ratio worsened despite a steady decline in interest on government bonds. The weighted average cost of government borrowings is down by nearly 250 basis points since FY15.

Economists blame it on the growing mismatch between tax revenues and government spending. “The overall size of the Budget continues to grow year after year but tax revenue has failed to keep pace due to a lack of tax buoyancy in the economy. The result has been a steady rise in government borrowings and interest payments,” said Madan Sabnavis head chief economist CARE Ratings. 

In the current fiscal year, interest payment is expected to grow by 13.2 per cent while the central government’s net tax revenue is expected to decline by 18.5 per cent.

Economist say the growing interest burden will become a macroeconomic headache if economic growth is less than expected in FY23. “We need to look at two things. First, the spread between growth in nominal GDP and interest rate on public debt and secondly the government’s primary deficit,” said Devendra Pant, chief economist India Ratings.

Primary deficit is the gap between government revenues and its total expenditure, excluding interest payment.

According to Pant, if nominal GDP growth stays above interest on public debt and primary deficit declines or turns positive, then the level of public debt is not a problem at all.  

The central government has consistently had primary deficit since FY09 and it has trebled between FY17 and FY20. Primary deficit is likely to double between FY20 and FY22.

A rapid rise in primary deficit means that the government is now borrowing to service past debt rather than raising public spending on social and infrastructure projects.

The Budget expects primary deficit of Rs 6.97 trillion in FY22 from Rs 3.21 trillion in FY20 and Rs 11.56 trillion in FY21.

Experts are banking on faster GDP growth and tax buoyancy to take care of the problem of India’s growing public debt.

“Public debt is growing across the world, so it’s not a big concern right now. If the expansionary fiscal policy results in faster growth in GDP and tax revenues in FY23 and beyond, then public debt will cease to be a problem,” said Dhananjay Sinha, head research Systematix Institutional Equity.

In the last five years (FY16 to FY21), India’s nominal GDP grew at a compound annual growth rate (CAGR) of 7.2 per cent while government tax revenues and interest payments grew at CAGR of 7.2 per cent and 9.4 per cent, respectively.

Going forward, analysts expect double-digit growth in nominal GDP and tax revenues and a cap on interest expenditure growth due to fiscal consolidation.