Amidst a global chorus of financial concerns, India's economy has emerged as a key player in a gripping fiscal tale. The IMF's projection of India's stable Debt-to-GDP ratio was disrupted by a pandemic-fueled surge, catapulting it to 88.5% in FY21.
What sets India’s economic landscape apart, however, are the remarkable factors that make its public debt situation sustainably lower than that of other countries.
This newsletter from ViTWO finance delves into the nuanced aspects of India's public finance and economic dynamics, shedding light on its moderate increase compared to other countries, its sustainable growth prospects, and the challenges that lie ahead.
Resilient Economic Growth & Debt-to-GDP Ratio
In simple terms, a country's Debt-to-GDP ratio compares the size of a public debt to its Gross Domestic Product (GDP).
India's Debt-to-GDP ratio, officially reported as 83% by the IMF, has witnessed only a modest increase over the past 15 years, unlike many other nations grappling with soaring debt levels like Japan, France, Canada, and the UK.
The Economic Survey 2022-2023 attributes this moderation to India's resilient economic growth, which has resulted in a positive growth-interest rate differential. As a result, the country has maintained sustainable debt-to-GDP levels, growing from 81% in 2005 to approximately 84% in 2021.
Debt Ratio Projection: India's Unique Debt Sustainability Factors
By projecting India’s debt-to-GDP ratio to be 84% of its GDP by the end of 2022, the IMF acknowledges that this level is higher than that of many emerging economies. However, India possesses distinctive characteristics that make its public debt more sustainable:
A significant portion of India’s debt is denominated in non-indexed domestic currency, mitigating external currency risks.
A large investor base within its borders supports public finance stability and debt sustainability.
India’s debt service ratio has shown a positive trend, decreasing from 10.1% in 2006 to 4.4% in 2011, and is estimated to be 5.2% in 2022. This indicates no immediate challenge to debt repayment.
Debt Vulnerabilities
India's debt vulnerabilities necessitate careful attention, particularly due to a 28.4 % increase in net market borrowings amounting to 11,74,375 crore in 2022-23. Meanwhile, India also recorded a huge spike in net market borrowings from 5,11,500 to 13,75,654 crore in 2020-21 during the Covid-19 pandemic.
Though India's debt ratio may be comparatively manageable, maintaining fiscal discipline and monitoring the fiscal deficit is essential. Currently, the fiscal deficit stands at 6.4% OF GDP IN 2022-23.
Growth, Inflation, & Debt Reduction
India's traditional high growth rate has been crucial in stabilising the debt-to-GDP ratio. However, to further fiscal consolidation must take center stage.
Keeping inflation in check while simultaneously reducing debt requires a reduction in the fiscal deficit. Meanwhile, experts emphasise the need for a gradual reduction in the deficit and highlight the importance of maintaining India's growth momentum.
Fiscal Reforms & Transparency
In order to bolster fiscal sustainability, several areas need closer attention. Experts suggest reversing the fuel excise tax cuts, which primarily benefit car owners rather than the economically disadvantaged.
Additionally, fiscal transparency should be enhanced to clarify broad fiscal objectives, provide information on government expenditure, and simplify revenue collection reporting. Improving fiscal transparency would enable the public to gain a better understanding of the government's financial activities.
5-Point Fiscal Precautions for India's Debt-to-GDP Ratio:
Monitoring Exchange Rate Volatility & Future Debt Accumulation
India's sharp depreciation of the rupee against the US dollar raises concerns about the future accumulation of external debt. A weaker currency can amplify the burden of debt repayment.
The Reserve Bank of India (RBI)'s interventions to stabilise the rupee may also deplete foreign exchange reserves. Continuous monitoring of exchange rate volatility is essential to anticipate and manage any adverse effects on future debt obligations.
Addressing Inflation & Its Impact on Interest Rates
India's current phase of inflation poses a risk to the economy. If inflation persists, the Reserve Bank of India may raise interest rates to curb it.
On the other hand, higher interest rates can impede economic growth and potentially increase the ratio of external debt to GDP. It is imperative to strike a delicate balance between inflation control and sustaining economic expansion to avoid future debt-related challenges.
Assessing Repayment Risks & the Shift to Non-Government Debt
With the non-government sector accounting for a significant portion of external debt, repayment risks may escalate in the future. Unlike the government, private entities and banks lack the option to negotiate concessional facilities or extend repayment liabilities.
Indian policymakers must recognise this shift in risk and factor it into their strategies to ensure the resilience of the non-government sector in debt distress scenarios.
Preparing for Potential Stagflation & Export Decline
The looming threat of stagflation in major global economies could adversely impact India's export earnings. A decline in export revenues can significantly affect the debt service ratio.Proactive measures should be taken to diversify export markets, promote domestic industries, and foster resilience in the face of potential decreases in future demand for Indian exports.
Anticipating Capital Flight & Preserving Foreign Exchange Reserves
As the US Federal Reserve continues to raise domestic interest rates to combat inflation, emerging economies face the risk of capital flight. Any capital outflows in India could deplete foreign exchange reserves, creating additional downside risks. Indian policymakers must closely monitor global developments and employ prudent fiscal and monetary policies to maintain adequate foreign exchange reserves and mitigate potential capital flight risks.
Final Thoughts
Over the previous decade and a half, India's public debt load has steadily increased. In 2006, the absolute value of external debt was US$139.1 billion, and it is currently US$620.7 billion.
However, India's GDP has expanded dramatically over this time. As a result, external debt as a percentage of GDP remained stable. India's unique debt sustainability factors, such as a significant portion of domestic currency-denominated debt and a robust investor base, contribute to its ability to sustain its debt burden.
ViTWO believes in maintaining a careful balance between growth, inflation, and fiscal deficit reduction. India's traditional high growth rate has been instrumental in stabilising the ratio, but efforts to decrease the deficit must be made.
By implementing appropriate fiscal reforms and enhancing transparency, India can strengthen its fiscal position and ensure sustainable economic growth in the long run.