What does the increase in public debt mean for the economy?

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The covid-19 pandemic has led to a larger budget deficit and a higher public debt-to-GDP (gross domestic product) ratio. However, the quality of public debt is also crucial: is the debt intended to cover capital expenditure or revenue expenditure? Mint explains the problem:

What does the ratio of public debt to GDP mean?

The public debt-to-GDP ratio is the ratio between what a country owes and what it produces, a measure of an economy’s financial leverage. Public debt consists of external debt (borrowed from foreign lenders) and domestic debt (government securities, treasury bills, short-term borrowings). A country that is able to continue to pay interest on its debt, i.e. without hampering economic growth and refinancing, is considered stable. According to the recommendations of the NK Singh Committee (2016), the debt to GDP ratio should have been 38.7% for the Center and 20% for the States by 2022-23 (FY23).

What are the current numbers?

The Center’s FY22 debt-to-GDP ratio was 59.9%, while FY23 budget estimates put it at 60.2%, due to increased government borrowing to in the face of the pandemic. It fell from 51% in FY13 to 48.1% in FY19. According to the Reserve Bank of India, the states’ debt-to-GDP ratio is also expected to be 31% in FY22, higher than the estimated 20%, which will lead to a debt-to-GDP ratio of around 90.9%. . According to the International Monetary Fund, India’s debt to GDP ratio for 2020 was 89.60% from 74.08% in 2019 and is expected to hit a record 90.6% in FY22.

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Debt burden

How does high debt affect the economy?

The increase in public debt leads to an increase in the burden of interest payments. This robs the government of its ability to undertake development and welfare measures. Interest payments as a percentage of revenue increased to 42% and 39% in FY21 and 22 from 36% in FY20. Rising public debt could also impact outlook from rating agencies.

How does debt lead to an inflationary crisis?

The widening budget deficit creates pressure on market interest rates, with the government being a major player. This affects private companies, thereby increasing the cost per unit which is passed on to consumers. This is cost inflation. Of course, the quality of the debt is also crucial, i.e. whether it is intended to cover capital expenditure or revenue expenditure. The first strategically supports the development process and contributes to medium and long-term economic growth. The latter is done to the detriment of future prospects.

How then to control the public debt?

The Fiscal Responsibility and Fiscal Management Act (2003) mandated the government to limit its budget deficit to 3% of GDP. This has helped ease the burden of interest payments, leaving more fiscal space for development and social protection measures. However, the pandemic has led to an increase in government borrowing. It is also important for the public to change their minds about gifts, because what is spent by the government is ultimately borne by the taxpayer.

Jagadish Shettigar and Pooja Misra are faculty members of BIMTECH.

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