High economic growth will spare India from debt trap, say experts

Finance panel had indicated that total debt could touch 90% of GD

With the Lok Sabha passing the Appropriation Bill on Wednesday, one of the crucial issues confronting the government is the high debt trajectory its expenditure boost will entail. 
 
The medium-term fiscal policy strategy tabled in Parliament along with the Union Budget did not delve into the debt trajectory as it would be dealt with by a new Fiscal Respo­nsibility and Budget Management (FRBM) law. However, the 15th finance commission’s recommendations prescribe a road map for the debt trajectory of the Centre and states till financial year 2025-26 (FY26).
 
The road map indicated that the total debt of the Centre and states could rise to an elevated level of 89.8 per cent of gross domestic product (GDP) in the current financial year and gradually reduce to 85.7 per cent by FY26. However, compared with the 70 per cent debt-GDP ratio seen in each of the three years before FY21, the commission’s level seems quite high even for FY26. This has given rise to fears of India entering a debt trap.
 
To a query on this, N K Singh, chairman of the finance commission, said he does not agree with the apprehensions. “No, I don’t think so (that the country will enter a debt trap). Looking at the fact that the states are also undergoing a recovery process, and if the growth is robust, I frankly think that the terminal numbers of the debt are not an unsustainable number,” he said.
 
He said as long as the primary objective of robust growth is achieved at the end of the award period, the needle of debt points southward and not north.

 
Devendra Pant, chief economist at India Ratings, said India’s performance has worsened on two important indicators for debt sustainability — difference between nominal GDP growth and average interest rate on debt, and primary deficit, which is difference between fiscal deficit and interest payment on debt.
 
“On both these counts, our performance has deteriorated in the past few years. On top of that, both these indicators have worsened in FY21, which has increased the debt-GDP ratio,” said Pant.  The focus should be on improving growth and reducing the primary deficit, he said.
While nominal growth in excess of average interest rate on debt will give some comfort on debt sustainability, primary deficit will continue to exert an opposite pressure, said Pant.
 
“If this situation of low growth and high deficit continues for a long time, we may inch towards debt trap, but as of now, we have not reached that situation,” he said.
 
Madan Sabnavis, chief economist at CARE Ratings, said it all depends on nominal growth of GDP, which will affect the ratio (debt-GDP).  “Debt will rise as we are talking of (Centre’s) deficit moving slowly to 4.5 per cent (in FY26). I don’t think it will lead to a debt trap if growth goes according to schedule,” he said.
 
Aditi Nayar, principal economist at ICRA, said to the extent that higher sovereign debt issuance is used to fund capex, it will act as an enabler of growth, instead of a force to crowd out private sector borrowers, and push up interest rates to an unattractive level over the medium term.
 
She said ICRA had expected the Centre to target bringing its fiscal deficit back to four per cent of GDP over the medium term, in a bid to help stabilise the debt-GDP ratio at a slightly lower level.
 
“For the state governments, the 15th Finance Commission has recommended a normal borrowing limit of four per cent of their respective gross state domestic product (GSDP) for FY22, declining by 50 basis points annually to three per cent of GSDP by FY24,” Nayar said.
 
In the Economic Survey for 2020-21, Chief Economic Advisor Krishnamurthy Subramanian also argued that growth leads to debt sustainability in the Indian context, but not necessarily vice-versa. This is because the interest rate paid by the Union government has been less than the country’s growth rate as a norm, not as an exception, he said.