Post #10 of the Quarantine series - India's government debt amidst the pandemic

The unprecedented coronavirus crisis has severely pressured the government finances. Not only is there expectations from the government to spend more for relief measures amidst these challenging times but also limited economic activities is weighing on the revenues of the government. There is one popular number which is often discussed which is “fiscal deficit” and that as a % of GDP. This number measures the quantum of borrowing to finance the gap between governments’ revenues and expenditure. Over time, just like an individual, the government repays the amount borrowed and borrows afresh. The residual amount which the government is likely to repay as on any given date is called as "outstanding government debt". 

There has been a lot of discussion about widening of India’s government debt since the announcement of the economic package and the 15^th Finance Commission (which looks after setting targets of fiscal deficit and government debt) is set to meet on May 21 to decide on the fiscal consolidation roadmap for 2021-22 to 2025-26. This roadmap will tell the target of fiscal deficit and government debt which they have to keep in mind over the next few years. Thus, post #10 of the Quarantine Series delves on some basics of government debt and tracks India’s debt positions over the years. 

Q1. What is government debt and what are the different variations/terminologies associated with it?

A1. Government debt is the outstanding amount of loan to be repaid by the government as on a given point in time. Different terminologies associated with it are provided in the chart below:

• Internal debt is the part of the government debt in a country which is owed to the lenders within the country. This is in the form of GSec (government securities), treasury bills, cash management bills, ways and means advances.
• External debt is the part of the government debt in a country which owed to the lenders outside the country. This form of borrowing is done from other governments and multi-lateral financial institutions like World Bank, IMF, other private institutions. 
• Total internal debt plus external debt is equal to public debt.
• Apart from public debt, there are other liabilities of the government like borrowings from National Small Savings Fund, state provident funds and other reserve funds.

 An equation below summarizes the above mentioned details: 

 Q2. How much is India’s government debt?

A2. India’s total government debt stood at Rs 146.9 lakh crs in as of 2019-20. This is the total debt of Centre and all the state governments taken together. Out of the total debt, 70% is held by the Centre while the balance 30% is held by the states. Popularly, the country’s debt is measured as a % of GDP. In India’s case, the India’s total government debt stood at 69.6% of India’s GDP in 2019-20. Total debt of the Central government is 48.6% while the 24.9% is that of the state governments in 2019-20. The trends in India’s government debt (As a % of GDP) has been provided below:

Chart 1: Trends in Indian governments’ debt to GDP ratio over the year

Q3. Where does India’s government debt to GDP stand in comparison to other countries?

A3. Out of a list of 173 countries, India ranks 38 in the ratio of government debt to GDP ratio which is notably lower than a few advanced economies like Japan, Italy, United States, France and United Kingdom. However, India’s debt is higher than Asian few peers like China, Thailand Malaysia and Philippines.

Chart 2: Country-wise comparison of government debt to GDP (%)

Q4. Why are we discussing about India’s government debt? Has there been any change in the number recently?

A4. Two developments on account of the coronavirus pandemic could have a bearing on India’s government debt.

• One is the likely increase in the central government’s fiscal deficit which means that the central government is likely to borrow more. India’s central bank has responded to this by increasing the government’s market borrowings to Rs 12 lakh crs for FY21, which is Rs 4.2 lakh crs higher than what was originally budgeted.
• Second is the likely increase in the state government’s borrowing during FY21 and this can be understood by the recent announcement by the Finance Minister to allow states to borrow additionally 2% of the GDP (out of which 0.5% is unconditional), subject to adherence to certain conditions. Even if the states avail the facility of additional borrowings, this could lead to states borrowing around Rs 2 lakh crs more from the market. 

So to put this in very simple terms, it means that as the governments are likely to spend more, they will have to fund the deficit by borrowing more and this could further add to the government debt. A back of the envelope calculation shows that India’s government debt to GDP ratio (both centre and states) could increase to 76-77% of GDP, from the current level of close to 70%. It was during 2002-05 when this ratio was little over 80%.

Q5. How has this number declined by almost 10% over the last 2 decades ? Is there some regulation implemented to monitor this?

A5. The governments have taken conscious efforts over the years to reduce the fiscal deficits over the years as the same has been mandated in the Fiscal Responsibility and Budget Management Act, 2003. Initially, the Act mandated the fiscal deficit to be reduced to 3% of GDP and only the recent FRBM Committee Review in May 2016 stated that this ratio should be targeted at 2.5% by 2023. In addition, the committee in 2016 also suggested using debt as a primary target and it was set at 60% of GDP (40% for the Centre and 20% for the states). In short, the committee has recommended that the government achieves a target of 60% by 2023. Given the uncertain times we are facing, a revision in the initial targets look likely.

Q6. Why is this increasing government debt number worrisome for the country?             

A6. The rising government debt has implications in the future in the form of additional interest cost for the government, puts pressure on interest rates which in turn can crowd out resources from the private sector and no additional fiscal space to deal with future shocks. In addition, two economists Reinhart and Rogoff have shown that for emerging economies there is a sustained increase in inflation in the country as the debt to GDP ratio increases.

 To end, I will like to pose a question to the readers: Will increasing government debt lead to higher inflation in coming years for a country like India or will we face deflationary trends like the one seen in advanced economies like Japan? Let's understand this point with some inputs from Irving Fisher's idea of the debt-deflationary trap in Post #11 of the Quarantine series. So do check out this space for the idea discussed above.