Managing public debt

India needs structural changes in economic management

The economic disruption caused by the spread of Covid-19 has increased budget management difficulties across the world. While the shutdown caused by the pandemic is affecting revenues, governments need to spend on containing the virus and support those who have been displaced by the economic disruption. As a result, the budget deficit and public debt are likely to go up in most countries. According to the International Monetary Fund, global government debt will cross the 100 per cent of gross domestic product (GDP) mark in the current year, compared with the level of about 83 per cent in 2019. The fiscal deficit will expand in India as well with a significant increase in debt. According to a new research note by the State Bank of India, higher government borrowing in the current fiscal year will push gross debt to 87.6 per cent of GDP. The collapse in GDP growth will push up the debt-to-GDP ratio by at least 4 percentage points. Consequently, the target of bringing down the debt to 60 per cent of GDP by 2022-23 will be pushed by about seven years.

The expansion in the budget deficit due to the pandemic shock is understandable, but what is worrying is that India’s public debt has been steadily rising. It increased from about 67 per cent of GDP in 2011-12 to 72 per cent in 2019-20. The debt situation should concern Indian policymakers for a variety of reasons. The rising debt stock would mean that in the coming years the government would need to set aside more resources for debt servicing. Further, even this high level of debt doesn’t represent the actual picture. For instance, a recent paper by the Reserve Bank of India noted that guarantees given by state governments could pose a potential risk to debt sustainability. The Union government also tends to shift liability to public sector enterprises. 

In the present circumstances, a number of commentators have argued that the government should go for direct monetisation of debt as it would help push expenditure and growth at a lower cost. And, since demand is depressed, this will not result in higher inflation. The idea sounds reasonable for dealing with a one-time shock. However, the fundamentals of the Indian economy make this proposition risky. For example, the disruption in economic activity has not led to a collapse in prices. Inflation remains above the target band of the central bank. Thus, debt monetisation could affect inflationary expectations, which will undo the potential benefits and increase macroeconomic risks.

Further, both the economy and government finances have structural problems, which cannot be addressed through debt monetisation. The Indian economy was slowing and the debt stock was steadily rising even before the pandemic. Therefore, while the focus at the moment needs to be on containing the pandemic, policymakers would do well to prepare a road map for large structural changes. As the economy recovers, the government would need to evaluate what all it can afford with the given budgetary constraints, and what it needs to do in terms of policy changes to attain higher sustainable growth. This might require reversing some recent policy decisions, such as in the area of trade. In the absence of required policy changes, among other things, debt servicing could become more painful and India may get trapped in lower levels of growth.