Shedding More Light On The Debt Dilemma

Relevance: GS3 - Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment. Government Budgeting. GS2 - Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

(Source: The Hindu, 07/27/2023)

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Why in the news?

• Author, M Govinda Rao, a former member of the 14th Finance Commission, has discussed India’s fiscal and public debt, which have risen to a concerning level in this article.

What are the challenges to the sustainability of India’s debt?

• Public Debt: India’s debt levels were high for an emerging country even before the Covid-19 pandemic.
  • India’s fiscal deficit in 2020-21 increased to 13.3% and aggregate public debt increased to 89.6%.
  • Although the fiscal deficit and public debt have recovered to 8.9% and 85.7% respectively, projections indicate that they may not return to pre-pandemic levels in the medium term.
• Electoral considerations: State Assembly elections scheduled for 2023 and the General Election in 2024 are likely to worsen the debt situation through increased electoral spending.
  • The introduction of targeted interventions to reduce debt may not be possible due to political considerations.
• Financial repression: Overall debt declines when there is no primary deficit if the GDP growth rate is higher than the effective interest rate paid on government bonds.
  • Financial repression which includes measures implemented by the government to keep interest rates low can lead to other distortions in the financial market.
• Deficits and debts: Interest payments account for over 5% of GDP and 25% of revenue receipts.
  • This results in the crowding out of necessary investments in physical infrastructure, human development, and the green transition.
  • It affects the ability of the government to respond to shocks, especially in states like Punjab, Kerala, Rajasthan, and West Bengal where the Debt to GSDP is 48.9%, 33%, 35.4%, and 37.6% respectively.
• Cost of borrowing: As the Indian debt market is mostly captive to banks and insurance companies, there is a scarcity of funds to lend to the manufacturing sector, thereby increasing the cost of borrowing.
  • Commercial banks have to maintain 4.5% of their funds as Cash Reserve Ratio (CRR), 18% as Statutory Liquidity Ratio (SLR), while 40% of credit is reserved for priority sectors.
• Debt to GDP ratio: The Finance Commission recommended that the Union government reduce its deficit from 43.6% in 2015-16 to 36.3% and the states were directed to maintain their deficit at 22%.
  • It also recommended a debt-to-GDP ratio of 58.2%. However, this is unfeasible in the medium term.

What are some steps to be taken for sustainability?

• Technology: Modern technology can be used to ensure the stabilization of the Goods and Services Tax (GST) regime.
  • Improved income tax compliance will boost tax revenues by 1.5-2% in the medium term.
• Policy actions: The state should withdraw from activities that are better handled by the market.
  • Focus on cash transfers for redistribution instead of subsidies which cause distortions.
  • Hard budget constraints should be imposed by the Union government to enforce Fiscal Responsibility and Budget Management rules on the states and prevent excess borrowing.

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FAQs

MCQs

Question: Consider the following statements:

1. Primary deficit is the difference between the total expenditure and income of the government.
2. GST is a revenue receipt.

Which of the above statements is/are correct?

(a) Only 1

(b) Only 2

(c) 1 and 2

(d) None