India has only one way to manage its post-pandemic debt burden

One of the more persistent economic burdens the pandemic leaves behind is the high level of public debt. This is a burden that will have to be eased in a decade rather than a few quarters. The fall in economic activity during the worst months of the pandemic forced the government to borrow more to run its essential services, provide some support to the poor and build infrastructure in the absence of strong private sector investment . Public debt as a proportion of India’s gross domestic product (GDP) rose by 15 percentage points in a year, a rate never seen before. It is expected to decline only gradually from the current 89.8% to 85.7% at the end of 2025-26, according to the estimates of the 15th Finance Commission. This would still be 25 percent higher than the recommendation of the committee to review the Fiscal Responsibility and Budget Management Act in 2017.

Most countries have seen their public debt plummet in revenues as well as increased spending after the pandemic, so India is no exception. Nevertheless, it is important to remember that the combined debt of the central government and states is 26 percentage points higher than the average for emerging market and middle-income countries, which stood at 64.3%. This is 20 percentage points higher than its Asian competitors. Much of this difference is not only due to what happened in the first two years of the pandemic, but also because India entered the crisis with weaker public finances than most comparable economies.

How do countries reduce their public debt as a proportion of their economy? Economists see three main factors of change – nominal economic growth, the interest rate the government pays on its debt, and the primary balance in the government budget. A useful rule is that the burden of public debt will automatically ease when the rate of nominal economic growth is much higher than the rate of interest the government will pay on its debt; The need for a sharp reduction in its primary deficit is relatively small. On the other hand, the government will have to aggressively reduce its primary deficit, or even aim for a primary surplus, if nominal economic growth is weak and/or interest rates rise. Another way of saying the same thing is that when the economy is growing rapidly and the government is paying lower rates of interest on its public debt, there is less need to go for fiscal austerity.

The charts here show the story of India since the turn of the century in terms of the interest rate on government borrowing (R), the nominal economic growth rate (G), and the difference between the two (RG).

India managed to reduce its ratio of public debt to GDP by 18 percentage points between 2002-03 to 2010-2011 due to its impressive growth acceleration; The central government reported a primary surplus in only two of those nine years. Thereafter the gap between interest rates and nominal GDP growth narrowed, as a combination of low inflation coupled with slow real growth led to a sharp decline in nominal economic growth. The dynamics of public debt in the first decade of the century was very different than in the second decade.

What about the thirties? Most estimates suggest that the public debt burden – and therefore the government’s interest cost – will remain high by historical standards until at least the middle of this decade. However, as long as economic growth is on track, there is no reason to be concerned about the stability of the Indian public debt. The International Monetary Fund says the debt-stable primary deficit for India is 2.9% of GDP, lower than the current high due to the pandemic but in line with the medium-term average level.

This has important implications for Indian macroeconomic policy. As monetary policy of the Reserve Bank of India turns towards inflation control, and thus attaches less importance to supporting the government’s financial actions, interest rates will begin to rise. The primary deficit will gradually come down to a permanent level over the next three years. Much will then depend on the Indian growth trajectory, in terms of bringing the ratio of public debt to GDP, without imposing premature austerity or inhibiting inflation control through fiscal dominance over monetary policy.

Every Union Budget has a central theme. Finance Minister Nirmala Sitharaman now has a good reason to make economic growth the focus of the new budget, which she is due to announce early next year.

Niranjan Rajadhyaksha is a member of the Academic Board of Meghnad Desai Academy of Economics