PUBLIC
DEBT OF INDIA CROSSING REDLINE

By CA  A. K. Jain

PREAMBLE :
Government borrowing plays a pivotal role in shaping a nation’s fiscal
landscape. It is a mechanism through which governments acquire funds to fuel
their various expenditures, from public services to infrastructure development.
The need for government borrowing arises when the revenue generated from taxes
and other sources falls short of covering the expenses outlined in the
government’s budget. Consequently, the government announces an annual borrowing
programme in its budget to bridge this fiscal gap.

“In the year 2014, the size of the Indian economy was 2.05 trillion dollars and
the total debt of the government of India was Rs 55,87,149.33 crore. In the year
2024, India is a 3.75 trillion economy. But the debt has trebled. In 10 years,
the debt has gone up three times. High debt accompanied by low employment and
high food inflation is the worst possible scenario for an emerging economy.

IMF OBSERVATIONS
Recent observations by the International Monetary Fund (IMF) sparked reactions
from the Indian Government. First, the IMF has raised concerns about the
long-term sustainability of India’s debts. Second, it reclassified India’s
exchange rate regime, terming it a “stabilised arrangement” instead of
“floating”.

These obsevations emerged from the annual Article IV consultation report, which
is part of the Fund’s surveillance function under the Articles of Agreement with
member countries. The report also acknowledged India’s effective inflation
management and projected a balanced outlook for India’s economic growth. While
the remark on the exchange rate can be viewed as comments on ‘excessive
management’, as the rupee moved in a narrow band due to Reserve Bank of India
interventions, the concerns on debt sustainability can be construed as a call
for more prudent management of debt in the medium term.

The IMF, in the report, states that India’s general government debt, including
the Centre and States, could be 100% of GDP under adverse circumstances by
fiscal 2028. According to them, “Long-term risks are high because considerable
investment is required to reach India’s climate change mitigation targets and
improve resilience to climate stresses and natural disasters. This suggests that
new and preferably concessional sources of financing are needed, as well as
greater private sector investment and carbon pricing or equivalent mechanism.”
The Finance Ministry refutes IMF projections as this is “a worst-case scenario
and is not fait accompli”.

The IMF team notes: “India’s economy showed robust growth over the past year.
Headline inflation has, on average, moderated although it remains volatile.
Employment has surpassed the pre-pandemic level and, while the informal sector
continues to dominate, formalisation has progressed”. The report further
highlights growing debt, accompanied by a “volatile inflation” spell, lower
employment (dominated by the informal sector), and a potential disruption of
global supply chain resulting in “increasing fiscal pressures for India”.

The Indian government’s response to the IMF report, particularly concerns about
debt, was unsurprisingly aimed at refuting the institution’s word of caution.
While the IMF highlighted a need for substantial investment especially from
India’s private sector to enhance the nation’s capacity to withstand climate
stresses and natural disasters, the GOI’s own response stressed that its
sovereign debt risks are limited as it is primarily denominated in domestic
currency.

These numbers of course rely upon data sourced by the IMF from India’s
government. There is always the possibility of ‘hidden debt’ arising from fiscal
deficit that’s ‘silently hidden’ and ‘not accounted for’ in official data. In
times of crisis, ‘hidden debt’ numbers can wreck an economy. India isn’t there
yet, but a large enough shock to the economy, amidst alarming government debt
numbers, could take it there.

India’s executive director at the IMF, challenged its claim, stating that
despite historical shocks, India’s public debt-to-GDP ratio has shown minimal
fluctuations. The disagreement centres on the IMF’s reclassification of India’s
exchange rate regime to a “stabilised arrangement”. The IMF data indicates how
government debt has increased to alarming levels of 82.4% (anything over 80% of
GDP is a red risk marker, in economic crisis terminology).

GDP DEBT RATIO :
There isn’t a universally accepted “good” ratio of foreign debt to GDP. It
depends on various factors specific to a country’s situation. However, some
benchmarks are used to assess sustainability:

Lower is generally better : A lower ratio indicates a country’s debt
burden is smaller relative to its economic output. This makes it easier to
service the debt and reduces vulnerability to external shocks.

Eurozone convergence criteria : Previously, the European Union had a
criterion for member states to maintain a government debt-to-GDP ratio below 60%

According to World Bank data (2021), India’s external debt to GDP ratio is
around 20%. This is considered a moderate level by international standards.
India’s national debt (which includes domestic and external debt) is around 80%
of GDP (2021). This is a higher figure, but it’s important to consider India’s
developing economy and ongoing infrastructure investments.

The ratio of foreign debt to GDP is an important indicator of a country’s
ability to manage its debt obligations. However, what constitutes a “good” ratio
can vary depending on factors such as the country’s economic stability, growth
prospects, and the structure of its debt. However, a commonly cited guideline is
to keep the foreign debt-to-GDP ratio below 40% to ensure sustainability and
mitigate risks associated with external debt.

It’s essential to interpret these ratios in the context of each country’s
specific circumstances, including factors such as economic growth, inflation,
exchange rates, and the structure of the debt (e.g., maturity, interest rates).
Additionally, countries with higher foreign debt ratios may face increased
vulnerability to external shocks, such as fluctuations in global interest rates
or exchange rates.

It is noticed that in developed countries with sound financial management the
ratio of debt to GDP a generally very high. Some of the examples are United
States- 121.31 , France- 111.8 • Japan- 261.29, United Kingdom – 101.36, Sweden-
32.69 , Spain- 111.6, Italy- 144.41.

The justification forwarded is, developed countries are in advantages position
from stability point of view and therefore various governments, business
institutions and individuals from all over the world park / invest their surplus
funds in these countries as deposits. These deposits are mentioned as debt. As a
matter of fact, funds parked in developed countries are not actually debt but
voluntary deposits. These deposits may be at times from legitimate or
illegitimate sources. The GDP and debt ratios of developed and developing
countries are not analogous. Any evaluation will be flawed and meaningless.

Debt – GDP ratios of a few well-managed developing economies are worth
mentioning. The examples are, Thailand – 54.3 %, Malaysia – 64.3 %, Mexico –
48.3%, Iran 34.8% & Middle East & North Africa 39.2%.

GROWING EXTERNAL DEBT OF INDIA

The tabulated figures indicate, apart from rising general government debt in the
last 10 year period, there is a sustained rise in external debt, too, along with
a gradual but persistent rise in household debt levels, at a time when real
incomes / wages have been regressively stagnant and consumer prices / inflation
has remained high.

DEBT MANAGEMENT :
Rising external debt requires a greater robustness of dollar/reserve currency
balance for a given country, which has been a concern for India’s balance of
payment position in recent times. The RBI has done everything possible to
exercise dollar selloffs for maintaining exchange rate stability in the currency
market for a depreciating rupee, and if one looks at the incoming flow mechanism
of forex into the country, macro-FDI levels have remained more or less the same,
even though foreign portfolio numbers have remained extremely volatile for India
(signalling a rise in hot money inflow/outflow and a loss in credibility of an
emerging market to attract long term stable investment via FDI).

The capex-fuelled government spending spree in the last three years hasn’t
allowed for greater capital formation (to attract private capital investment for
growth). The weak Gross Fixed Capital Formation numbers reflect this. That’s an
even bigger concern. If the government is spending big and doing so by borrowing
more to attract/progressively push for growth via private investment, and none
of that is happening (private investment remains woefully weak), the government
is basically accruing more debt at the cost of spending to waste and endangering
the possibility of future usefully borrowing for crisis or large-scale credit
needs.

High debt accompanied by low employment and high food inflation is the worst
possible scenario for an emerging market, particularly one that boasts of a
demographic dividend in its working age population composition. India’s growth
story is one of jobless growth anchored by higher in formalisation of work, in
absence of ‘good jobs’.

Manufacturing production is still weak and where the potential for jobs is
higher, in services, the nature of competitiveness (in a worker surplus economy)
does not yield higher wages. Workers are settling for low-value service work,
much of it at the intersection of ‘informal’ and ‘formal’ work.

Learning from the higher growth episodes of China from the 1980s, it is evident
that for any large emerging market to progress and aspire to higher growth while
drawing people out of poverty, having a larger credit expansion plan in its
financial sector is vital, along with a larger borrowing space for
crisis/exogenous shocks/disruptive responses.
If we consider, the bank credit trend accompanying the rise in government debt
level, one sees that even as credit is growing in India’s financial sector
(which is vital for growth prospects) a higher debt level, amidst a lower growth
cycle, will leave less space for both long-term credit expansion or borrowing to
happen. One is quite sure that the RBI would be aware of this.

IMPACT OF GDP DEBT RATIO ON FOREIGN EXCHANGE RATES :

The impact of a country’s GDP debt ratio on its foreign exchange rate is a
complex dance with no guaranteed steps. Here’s a breakdown with examples and
statistics to illustrate the potential cause-and-effect:

Japan : Despite having the world’s highest debt-to-GDP ratio (over 230%
in 2021), Japan’s Yen hasn’t necessarily depreciated significantly. This is
because a large portion of the debt is held domestically, and Japan’s strong
economy inspires investor confidence. However, concerns about future debt
sustainability can still weigh on the Yen.

Greece : Greece’s debt crisis in the late 2000s provides a stark example.
A soaring debt ratio (over 170% of GDP in 2011) eroded investor confidence,
leading to capital flight and a significant devaluation of the Euro within
Greece (since the Euro is a shared currency).

China : China’s debt ratio has been rising (around 60% in 2021), but its
managed exchange rate system and continued economic growth have helped maintain
a relatively stable Yuan. However, long-term debt sustainability remains a
concern.

United States : The US has a high debt ratio (over 100% of GDP in 2021).
However, the US Dollar remains the world’s reserve currency, and the US economy
is still considered large and relatively stable. However, the long-term impact
of high debt on the Dollar’s future dominance is a topic of debate.

The examples are just snapshots, and the situation can evolve over time. A
country’s overall economic health, political stability, and global economic
conditions all play a role in shaping the relationship between debt and foreign
exchange rates.

POOR DEBT MANAGEMENT A FEW CLASSIC EXAMPLE

Several historical examples illustrate how high levels of debt can contribute to
the collapse of a country’s economy:

Republic of Germany : After World War I, Germany was burdened with
massive reparations payments to the victorious Allied powers. In an attempt to
meet these obligations, the German government printed vast quantities of money,
leading to hyperinflation. This destroyed the value of the German currency, the
Mark, and caused widespread economic chaos.

Mexico (1980s) : Mexico faced a debt crisis in the 1980s known as the
“Lost Decade.” High borrowing to finance ambitious development projects, coupled
with falling oil prices, led to a debt crisis and a severe economic downturn.
Mexico eventually had to undergo structural adjustment programs under the
guidance of international financial institutions.

Malaysia : Malaysia’s economy faced challenges related to high levels of
debt . Like many countries, Malaysia has experienced fluctuations in its
economic performance due to various factors including debt levels, global
economic conditions, and domestic policies. In the late 1990s, Malaysia faced a
severe financial crisis triggered by a combination of external factors such as
the Asian financial crisis and internal issues like high levels of debt and
currency speculation.

Russia (1998) : Russia experienced a major financial crisis in 1998,
triggered in part by high levels of debt. The government had accumulated
significant foreign debt, much of it denominated in U.S. dollars, and when the
Russian ruble depreciated rapidly, the country defaulted on its debt
obligations. This led to a sharp economic downturn and widespread financial
instability.

These examples demonstrate the risks associated with high levels of debt and the
potential for it to contribute to the collapse of a country’s economy if not
managed effectively.

Zimbabwe (late 2000s) : Zimbabwe’s economy collapsed in the late 2000s
due to a combination of factors, including excessive government spending,
hyperinflation, and political instability. The government’s reckless fiscal
policies, including printing money to finance its budget deficits, led to
hyperinflation reaching astronomical levels, rendering the currency virtually
worthless. The collapse of the economy resulted in widespread poverty,
unemployment, and social unrest.

Argentina (2001) : Argentina experienced a major economic collapse in
2001 following a decade of economic mismanagement and excessive borrowing. The
country’s debt reached unsustainable levels, and it defaulted on its debt
obligations, causing widespread financial panic and social unrest. The Argentine
government implemented a series of devaluations and austerity measures, leading
to a deep recession and a sharp increase in poverty and unemployment.

Iceland (2008) : Iceland’s economy collapsed in 2008 due to a combination
of factors, including excessive borrowing by its banking sector, a housing
bubble, and a reliance on foreign debt. The collapse led to a banking crisis,
currency depreciation, and a deep recession.

Venezuela (2010) : Venezuela’s economy has been in a state of collapse
for several years, largely due to mismanagement, corruption, and excessive
borrowing. The government’s heavy reliance on oil revenues, coupled with
declining oil prices, resulted in fiscal imbalances and unsustainable debt
levels. Hyperinflation, shortages of basic goods, and a sharp decline in living
standards have plagued the country, leading to a humanitarian crisis.

Greece (2010) : Greece faced a severe debt crisis in 2010, which led to
an economic collapse. The country had accumulated high levels of debt due to
years of government overspending, tax evasion, and corruption. Greece’s debt
reached unsustainable levels, and it was unable to meet its repayment
obligations. This led to a bailout package from the International Monetary Fund
(IMF), the European Central Bank (ECB), and the European Commission (EC), which
came with stringent austerity measures. The Greek economy contracted
significantly, and unemployment soared.

These examples demonstrate the devastating consequences of high levels of debt
when coupled with economic mismanagement, corruption, and external shocks.
Economic collapse can result in widespread suffering, including unemployment,
poverty, and social unrest, and it often takes years for affected countries to
recover.

INFERENCES :
Looking at these numbers, one thing is clear: India is experiencing a ‘debt
crisis problem’. ‘Crisis’ needs to be viewed not in terms of present debt volume
but in the larger trend and macroeconomic connection observable between rising
government debt and other macro aggregates (from growth, employment, inflation,
to financial credit expansion). The government would need to take serious fiscal
consolidation measures to address these challenges, rather than living in denial
and refuting mode.

Under the umbrella of market borrowing, the Indian government also issues
special securities to entities like oil marketing companies, fertiliser
companies, and the Food Corporation of India. These are often referred to as oil
bonds, fertiliser bonds, and food bonds, respectively. These securities serve as
compensation to these entities in place of cash subsidies and are typically
long-dated with slightly higher coupons than regular securities. While they do
not qualify as statutory liquidity ratio (SLR) securities, they are eligible as
collateral for market repo transactions.

State Governments participate in market borrowing by issuing State Development
Loans (SDLs). These securities, issued through auctions, serve as a means for
state governments to raise funds. Like central government securities, SDLs
qualify for SLR and can be used as collateral for market repo transactions.

The Centre is planning to raise Rs 7.5 trillion through market borrowing in the
April-September period of 2024-25 to fund the revenue gap to push economic
growth. Out of gross market borrowing of Rs 14.13 trillion estimated for
2024-25, Rs 7.5 trillion, or 53 per cent, is planned to be borrowed in the first
half (H1).

This borrowing includes the issuance of Sovereign Green Bonds (SGrBs) worth Rs
20,000 crore. The government aims to meet its fiscal deficit primarily through
market borrowings. Weekly borrowing through the issuance of Treasury Bills in
the third quarter of the fiscal is expected to be Rs 24,000 crore, with net
borrowing of Rs (-)52,000 crore during the quarter. The ministry said that the
Reserve Bank of India has fixed the Ways and Mean Advances (WMA) limit for the
October-March period of 2023-24 at Rs 50,000 crore to take care of temporary
mismatches in Government accounts. India will spend almost 25% of national
budget towards debt management.
The Department of Expenditure under the Ministry of Finance handles the
Government of India borrowing programme. The borrowing programme is finalised by
the Government of India in consultation with the Reserve Bank of India.

Government borrowing has a dual impact on the economy. Firstly, when the
government borrows extensively from the market, it leaves limited space for
private sector entities and corporations to access the market for their
financing needs. This can crowd out private investment. Secondly, substantial
government borrowing can lead to increased interest rates across the board.
This, in turn, raises the debt repayment burden of the government and drives up
the cost of borrowing for other entities. High-interest rates can also hamper
economic growth by discouraging investment.