“What joke?” asked Rahul.
“How many engineers does it take to change a light bulb?”
“How many?”
“None, actually. They simply come together and define darkness as the new industry standard.”
“That was in bad light Pooja,” replied Rahul. “You know, I also read a very interesting joke on Forbes.com: How many economists does it take to change a light bulb?”
“How many?”
“None. Because darkness will cause the light bulb to change by itself. The free-market will sort itself out.”
“On a serious note, I have a question for you,” said Rahul, who is an engineer, to Pooja, who is an economist.
“Bring it on.”
“So, someone Whatsapped today. It seems the International Monetary Fund (IMF) recently said that India’s debt level remains elevated and will touch 100% of the gross domestic product by 2028. What do you think?”
“That’s the trouble with WhatsApp. People make definitive, confident and easy-to-understand statements, which other people end up believing.”
“But I haven’t believed anything,” said Rahul. “And which is why I am asking you.”
“Tell me something,” said Pooja, yawning and craving a cup of black coffee. “Do you understand the central government’s budget?”
“Well, it’s scheduled for 1 February that much I know.”
“So, let’s talk about it,” said Pooja.
“Okay.”
“What’s scheduled this time around is the interim budget.”
“Interim budget?” asked Rahul.
“Yes, with the Lok Sabha elections due in a few months. The proper budget for 2024-25, the next financial year, will be presented by the next government after it has been elected. Typically, from past experience I can tell you that this usually happens in July.”
“Okay. But I had asked you a question on India’s debt, so, why are we talking about the budget then?”
“Have some patience my dear,” said Pooja, while logging on to an app and ordering two cups of coffee, an Americano for herself and a cup of Cortado for Rahul. Rahul, liked his coffee, nice and milky—like his mother still made it—or flat white as they tend to call it these days. But his wife wanted to make him much more than just his Mumma’s Complan boy that he still was. And so he decided to keep quiet. This wasn’t a battle worth picking.
The borrowing plan
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Every year, the finance minister presents the government’s budget on 1 February. The long-speeches notwithstanding, the budget is primarily a statement of accounts for the next financial year,” said Pooja.
“A statement of what?” interrupted Rahul.
“Basically, the government puts out the details of the expenditure it expects to carry out during the year, along with how it expects to finance that expenditure.”
“Right.”
“The budget for 2023-24—the financial year that’s currently on—was presented on 1 February 2023. The government budgeted to spend around ₹45.03 trillion during the year and it expected its total earnings to be around ₹27.16 trillion.”
“Oh, but that’s a huge gap.”
“Yes, it’s a gap of ₹17.87 trillion, or if I were to put it in other words, the gap amounted to around 40% of the government’s total expenditure of ₹45.03 trillion.”
“Okay.”
“So, this gap of ₹17.87 trillion is referred to as the fiscal deficit.”
“Ah, that’s what it means,” said Rahul. “Your folk use this term more than my folks say AI these days.”
“Well, if you are an economist living in Delhi,” said Pooja, “you can’t make a living without using this term at least three-four times a day on average.”
“Sarcasm?” asked Rahul, showing all over again the limited ability of many engineers to understand anything that had some ambiguity in it.
Pooja continued, ignoring his question. “Now, the fiscal deficit needs to be financed.”
“How is that done?”
“A large part of it is financed through the government borrowing money. In 2023-24, the government expects to borrow a total of ₹12.31 trillion to finance the fiscal deficit.”
“How does the government borrow money?”
“It issues financial securities referred to as government securities, or G-secs for short.”
“Hmmm.”
“These securities pay a certain rate of interest. Banks are required to compulsorily invest a good proportion of the deposits that they raise into these securities. Insurance companies also invest in G-secs. In fact, people are incentivized to buy insurance policies, among other forms of investing, by offering tax benefits. The ultimate idea is to ensure that there is, at any point of time, enough money going around to finance the fiscal deficit. And mutual funds also buy G-secs. These days, it’s possible for individuals to buy G-secs directly as well through investing apps.”
“Interesting.”
“So, the central government’s fiscal deficit is largely financed in this way. And that’s how it ends up borrowing money and accumulating debt, given that it runs a fiscal deficit every year. Now, it’s not just the central government which runs fiscal deficits. The state governments also do so, and they also borrow to finance these deficits and end up accumulating debt, like the central government does.”
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Small is big
Now, correct me here, you said that the fiscal deficit of the central government in 2023-24 is projected to be at ₹17.87 trillion, but it is expected to borrow only ₹12.31 trillion. This does not fill up the gap between its earnings and expenditure,” said Rahul.
“Yes,” said Pooja. “So, a bulk of the remaining gap is financed through small savings schemes. In 2023-24, they are expected to bring in ₹4.71 trillion.”
“Expected to bring in?” asked Rahul.
“So, the government, largely through the post office, runs investment schemes like the Public Provident Fund, the Senior Citizens Savings Scheme, the National Savings Certificate, etc. People invest money into these schemes every year. At the same time, some investments made in earlier years mature and, hence, need to be redeemed. In 2023-24, it is expected that ₹6.48 trillion will come into these schemes and ₹1.77 trillion of investments made earlier will mature. These maturing investments will be repaid out of the money coming into the schemes. And after this is done, ₹4.71 trillion will be left, which will be used to finance the fiscal deficit.”
“That’s interesting. So, money being invested by individuals in the small savings schemes during a year is used to pay off investors whose investments are maturing in that year,” surmised Rahul.
“Yes, you are right,” replied Pooja. “In the simplest sense, the money invested in small savings schemes at any point of time is a liability for the government of India. If, in any given year, the money being invested in these schemes is lower than the money that needs to be redeemed, then the central government will have to make good of it.”
“Okay.”
The big debt question
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Other than the small savings schemes, the central and the state governments have other outstanding liabilities as well. For 2023-24, data from the Centre for Monitoring Indian Economy shows that when you add up all these numbers, using the budget of the central government presented in February 2023 and other reports, it comes to ₹252.79 trillion.”
“Hmmm.”
“Now, we have been talking about numbers in absolute terms up until now. Nonetheless, we need to take the size of the Indian economy or its gross domestic product (GDP) into account as well. So, as per the budget presented on 1 February 2023, the GDP in 2023-24 is expected to be at ₹301.75 trillion. This is GDP in current terms, not adjusted for inflation and it implies that the total debt and liabilities of the central government and the state governments work out to around 83.8% of the GDP.”
“What does that mean?” asked Rahul.
“I am coming to that,” replied Pooja. “We are dealing with estimates here and estimates get revised. As per the First Advance Estimates of the GDP released in early January, the GDP this year is now expected to be ₹296.58 trillion. Taking this into account, the ratio of total debt and liabilities goes up to 85.3% of the GDP.”
“Hmmm.”
“Nonetheless, we are assuming here that the sum of borrowings and liabilities of the central government and state governments will stay the same as projected at the beginning of this financial year. Now, that may not turn out to be the case. Given that, total debt and liabilities as a proportion of the GDP might be lower than the calculations we have talked about. The IMF puts it at around 81.9% in 2023 and 82.3% in 2024.”
“So, where did the talk about India’s debt level reaching 100% of GDP come from?” asked Rahul.
“I was getting to that,” said Pooja. “If we look at the ratio of the debt and liabilities of India’s central government and state governments, it peaked at 95.1% of the GDP in March 2004, around 20 years back. It then started to fall, and fell to around 72.8% of the GDP in March 2014 and fell a little further to 72.1% in March 2015, and then jumped a little to 73.4% by March 2019.”
“And then covid struck,” Rahul interrupted.
“Yes. So, the ratio ballooned to 92% of the GDP in March 2021, as governments had to spend more in an environment where the private sector of the economy was in great trouble. Also, tax revenues fell, forcing the governments to borrow more. The ratio has since been falling and should continue to fall. The IMF has basically said that if the Indian economy faces a shock, this ratio will balloon to 100% of the GDP in the medium term by 2028. In the normal scheme of things, it expects the ratio to come down to 79.9% of the GDP by 2028, which is higher than where it was in years before covid, but only slightly.”
South American way?
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“Okay. You know there is something else that the WhatsApp forward I received said—that India will now go the South American way,” said Rahul.
“That’s total rubbish,” said Pooja.
“Why?”
“South American governments, over the years, have borrowed a lot of money in foreign currencies, particularly US dollars. And they have been unable to repay these debts and even defaulted on them. This has played havoc with their economies.”
“Hmmm.”
“The borrowing by Indian governments is largely in Indian rupee terms. The external debt and liabilities of the central government, as of March 2024, are expected to be ₹5.23 trillion or around 3.1% of its expected total borrowing and liabilities of ₹169.47 trillion.”
“So?” asked Rahul.
“You know there are three things that make a government a government.”
“Which are?”
“The right to tax, the right to legal violence and the right to print money.”
“And how is that linked to what we are talking about?”
“In an economic scenario when things aren’t looking good and the debt has burgeoned beyond control, the government can always increase tax rates and hope to repay debt at a faster pace. This is something which doesn’t help beyond a point if the government debt happens to be in a foreign currency. In an extreme situation, the government can always print money and repay the debt, something which cannot be done when the debt is in a foreign currency,” explained Pooja. “Of course, this will have other economic repercussions. But India has no chance of going the South American way.”
“Hmmm.”
“Which is why you shouldn’t be reading too many WhatsApp forwards and learning from Insta reels,” said Pooja, having the last word.
The doorbell rang. The coffee had arrived and Rahul, taking a sip from his Cortado, told Pooja: “Next time, please order a flat white for me dear. This half a cup of Cortado at this price is a scam.”
Pooja got up and got to Rahul’s side of the table. Gently caressing his hair, she said: “Awww. I surely will, Mumma’s boy. And as your mother would have put it, for this price, we could have easily bought four litres of milk.”
(The example is hypothetical).
Vivek Kaul is the author of Bad Money.