India's debt to GDP ratio at a 14 year high

The Union government's debt rose to 58.8% of the gross domestic product (GDP) in the fiscal year 2020-21, up from 51.6% in 2019-20.

India's debt to GDP ratio at a 14 year high

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• The story: The Union government's debt rose to 58.8% of the gross domestic product (GDP) in the fiscal year 2020-21, up from 51.6% in 2019-20. This was due to economic contraction, which forced the government to borrow huge amounts (from the market) to meet a revenue shortfall. This raises some concerns over debt sustainability in the medium term.  (Debt sustainability - ability to comfortably service debt obligations (principal and interest))
• Deficits: The fiscal deficit grew to 9.2% of GDP in FY21 from 4.6% of GDP in FY 20, largely as revenue receipts contracted 3%. The economy shrunk by 7.3% (GDP contraction). This was the steepest contraction in independent India, due to Covid-19 disruptions. India has had five recessions in all so far, with 2020's recession being the latest. Also note that deficits eventually add up to debt.
• What is debt: The Union government debt includes (a) the stock of total liabilities due to internal debt raised through treasury bills, bonds and securities; (b) external debt mainly raised from multilateral institutions; and (c) public account liabilities such as provident fund commitments and National Small Savings Fund.
• GDP growth and debt-to-GDP ratio: The higher debt-to-GDP ratio in FY21 was due to the GDP contraction, which led to the denominator shrinking. Debt sustainability from a medium-term perspective can show a different picture.

1. Despite Covid-2.0, the nominal GDP growth in FY22 may be 12 - 14%. This will push the debt-to-GDP down by at least by one percentage point.
2. To have sustainable debt, strong GDP growth momentum has to be maintained. That will give annual relief in the way of lower fiscal deficits.

• Rating agencies: In May 2021, rating agency Moody’s found three constraints for India’s credit profile - (i) obstacles to economic growth, (ii) a high debt burden and (iii) a weak financial system. It warned that the longer the period of relatively subdued growth, the more likely it would be that India’s debt burden will continue to rise. Further contingent liabilities for the government may rise if it decides to give renewed financial support to financial institutions.
• Finance Commission: The Fifteenth Finance Commission (FFC) had said that fiscal uncertainty was at an all-time high amid covid. The Nominal GDP and government revenues contracted in FY21 and placed distinct upward pressure on Union and states’ fiscal and debt positions. This upward pressure was unavoidable when growth destruction must be mitigated, and income support extended. This is the reason to consider flexibility. These are extraordinary times (October 2020).
• FRBM's irrelevance in today's India: The Fiscal Responsibility and Budget Management (FRBM) Act, as amended in 2008, mandated the debt-to-GDP ratio to serve as the medium-term anchor for fiscal policy, with the fiscal deficit as the operational target. It mandated the debt-to-GDP ratio of the Centre to be brought down to 40% and that of states to 20% by 2024-25.

1. Those earlier targets have lost all relevance due to past 3 years of Indian economic reality
2. The FFC thus recommended setting up an FRBM review panel to draft a new fiscal consolidation framework because the current challenges have made the earlier targets impossible to achieve.

• Summary: Since the general government debt (states and Centre’s debt) may have crossed 90% in FY21, the FFC recommended a slow and gradual decline in central government and general government debt to 56.6% and 85.7% (of GDP), resp., by FY26 due to adverse debt dynamics over the next few years. The journey ahead is not going to be easy at all. 
  
  
• Given below are images related to latest figure for Union govt., and the 15th Finance Commission report's estimate for next few years.

 

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