In the context of India, public debt encompasses the cumulative financial obligations of the Union government that are to be settled using the Consolidated Fund of India. Sometimes, the term is also used to denote the overall liabilities of both the central and state governments. Public debt in India is sourced from various channels, including dated government securities (G-Secs), treasury bills, external assistance, and short-term borrowings.
Over the years, the Union government’s debt has risen significantly, reaching a 14-year high of 58.8% of the GDP in 2020-21, compared to 51.8% in 2011-2012.
The escalating burden of public debt raises concerns due to the following reasons:
- Mounting interest payments: The government’s increasing borrowings result in additional expenses in the form of interest payments on the outstanding debt.
- Sovereign debt crisis: As interest rates rise, it becomes more expensive for a country to refinance its existing debt. Consequently, a significant portion of the income has to be allocated towards debt repayment rather than funding essential government services. This situation, akin to the sovereign debt crisis experienced in Europe, could potentially arise.
- Inflationary pressure: Expanded government spending or reduced taxes can boost aggregate demand, leading to demand-pull inflation.
- Crowding out effect: Excessive public debt results in higher interest rates due to a higher risk premium. This, in turn, leads to reduced private investment and a contraction in GDP in the long run.
- Burden on future generations: By resorting to borrowing, the government transfers the burden of reduced consumption to future generations. While the government issues bonds to the current population, it may choose to pay off those bonds at a later date, such as after twenty years, by raising taxes.
- Debt sustainability: An increase in the primary deficit and a decline in the interest rate growth differential can raise doubts regarding the sustainability of India’s debt.
- Fiscal space: A wide fiscal deficit leaves minimal room to absorb additional adverse shocks without compromising credit ratings.
- Credit ratings: When the debt level approaches a critical point, investors typically demand higher interest rates. If the country continues to spend recklessly, its bonds may receive a lower credit rating, indicating a higher likelihood of defaulting on the debt.
In emerging high-growth economies like India, the government must allocate sufficient funds to drive economic growth through infrastructure development and other essential resources. Consequently, governments need to strike a delicate balance with public debt, ensuring it is substantial enough to stimulate economic growth while keeping interest rates low.