INDIA’S RISING DEBT CHALLENGE

Analysing the fiscal deficit levels and mounting debt challenges…

InfoSphereA Centre for New Economics Studies Initiative

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Aliva Smruti, Archita Sridhar, Divyansh Singh Parihar, Diya Chadha and Swasti Ray

INTRODUCTION

The COVID-19 crisis has dealt a heavy blow on a country’s health infrastructure and economy. Union Governments across the world have responded with multiple rounds of countercyclical measures-to boost spending or liquidity injection, resulting in a steep increase in fiscal deficit and overall debt.

The Indian Government, however, only increased its direct government spending by approximately 1% of its GDP even after downward-moving growth prospects. Moreover, international credit rating agencies like Moody’s* recent downgraded of India’s overall ranking due to concerns of increased debt.

We analyse India’s fiscal deficit volume and its overall debt-composition in this InfoSphere Issue

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*Moody's is a credit rating agency that ranks creditworthiness of a borrower using standardized ranking scale that measures the expected investor loss in the case of default in repayment of debt.

This InfoSphere Issue shall focus on:1. Analysis of current Debt and Deficits,2. Analysis of the recommendations given by the Fiscal Responsibility and Budget Management (FRBM) review committee,3. Structure and Composition of Public debt in India,4. The relationship between market borrowings, reserve money and fiscal deficit and inflation,5. Open Market Operations and6. Role of RBI during the Covid-19 crisis.

Source: WorldPress.com

Glossary

Balance of Payments – records all international trade and financial transactions made by a country’s residents.

Fiscal Deficit – condition when government’s expenditure exceeds its receipts in a given fiscal year.Typically calculated as a % of GDP.

Revenue deficit – when government’s own earnings are not sufficient to meet the day-to-day operations of its departments.

Revenue Expenditure – payment of salaries, pension, interests, expenditure on administration, defence, health, and other services in the country.

Revenue Receipts – Tax receipts including income tax, corporate tax, custom duties, excise and other duties levied by the government and non-tax

revenue receipts such as interest and dividends on investments made by the government.

Debt-GDP ratio – ratio comparing the country’s sovereign debt to its economic output (measured in terms of GDP).

Monetary Policy– Central bank activities directed towards influencing quantity of money and credit in the economy.

Fiscal Policy – Government decisions about taxation and government spending.

Counter cyclical measures – a fiscal strategy of the government to suppress or alleviate economic overheating or recession (in times of economic

contraction, an increase in expenditure and reduction in revenue is a counter-cyclical measure).

Open Market Operations (OMO) - purchase and sale of government securities (G-Secs) and treasury bills by RBI to smoothen liquidity.

Bond Yields – Rate of return on a bond. Bond prices fluctuate daily and hence yield also fluctuates based on bond prices. When price goes up, yield goes

down and vice versa.

Reserve Money – A sum of currency in circulation, banker’s deposits with RBI and other deposits (deposit with foreign central banks, financial

institutions) with RBI.

Monetization of debt – Reserve Bank of India (RBI) directly purchases government securities in the primary market to help the central government

meet its expenditure, by printing more money at the cost of high inflation and currency depreciation.This practice was phased out and ended in 1997.

To know more: https://economictimes.indiatimes.com/definition/category/Budget

Amendment FRBM Act 2018

Taper Tantrum

(2013)

Financial Crisis(2009)

Fiscal Responsibility and Budget

Management (FRBM) Act

2003

Balance of Payment

Crisis(1991)

Time Line for FRBM Acts

1. Fiscal deficit at 6% of GDP

2. Revenue deficit at 0% of GDP3. Restricted

government from borrowing from

RBI.

General government Debt at 60%

of GDP

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AMENDMENT TO FRBM ACT 2018- KEY TAKEAWAYS

• Medium term target for fiscal policy shifts from fiscal deficit to debt; fiscal deficit would be an intermediate target.

• Revenue deficit surplus creation scrapped from the act.

• Debt recommendation at 60% of GDP; central government debt to be 40% of GDP and state government debt to be 20% of GDP.

• Contingency liabilities may become high as economy goes into business cycle downturn.

To know more: https://dea.gov.in/sites/default/files/Volume%201%20FRBM%20Review%20Committee%20Report.pdf

Source: FRBM Review Committee ReportInfoSphere

RECOMMENDED PATH FOR FISCAL

CONSOLIDATION FOR CENTRAL

GOVERNMENT

69.7 69.9 69.6 69 68.3 67.6 66.9

49.447.3

45.543.7

4240.3

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2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24

Deb

t-to

-GD

P(%

)

Debt-to-GDP Ratio

Debt-to-GDP(%) Debt-to-GDP(%) Recommended

• The Central Government has been constantly missing the targeted debt-to-GDP ratio.

Increase in public debt can crowd out private sector borrowing hampering growth.

Growth in the economy is associated with increase in revenue receipts; reducing future debt.

Source: Article IV Report, FRBM Review Committee ReportInfoSphere

DEBT AND DEFICIT TREND (FY 2007-08 to FY 2019-20)

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al a

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even

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efic

it (

% G

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)

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t-to

-GD

P (

%)

Debt-to-GDP(%) Fiscal Deficit Revenue Deficit• Debt-to-GDP ratio has remained consistently above the required 60% - the medium-term target.

• Since the global financial crisis, government has failed to meet its Fiscal deficit target of 6% of GDP, year after year.

• The target was met only for 2 years after the enactment of the FRMB act - 2005-06 and 2006-07.

Source: RBIInfoSphere

Source: RBI

Following the financial crisis of 2009-10, revenue deficit witnessed a steep increase to 5.8% of GDP in FY 2009-10 and on an average remained in similar range.

Post 2007-08, Union government failed to bring Revenue Deficit down to zero, in accordance with FRBM 2003.

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enue

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icit(

%).

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t gr

owth

(%)

GD

P gr

owth

(%

)GDP growth rate Revenue Deficit (% GDP) Debt growth rate

With a unit increase in 1. Square of debt, GDP growth rate decreases by 2.98312E-142. Revenue deficit, GDP growth rate decreases by 0.77This results are significant at 95 per cent confidence level.

On Regressing Effect of Debt and Revenue Deficit on Indian GDP Growth rate, we find that

The high Debt-to-GDP ratio increases the yield (interest) rates of government bond. This in acute case when the yield rates are higher than GDP growth rate, the issue of solvency could crop up. However, the regression shows there is very little change in the growth rate due to debt as historically, yield rates have never crossed the growth rate of GDP.

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ctiv

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t ra

tes,

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f GD

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Year

Effective interest rates and GDP growth rates

Effective Interest rate GDP growth rate Linear (Effective Interest rate)

Source: RBI

Refer to results in the last slide

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India Columbia Hungray Indonasia Mexico Peru Russia South Africa Thailand Turkey Uruguay Average of similar EM

Ave

rage

Deb

t (%

GD

P)

Average Debt (% GDP) for similar Emerging Markets

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India Columbia Hungray Indonasia Mexico Peru Russia South Africa Thailand Turkey Uruguay Average of similar EM

Fisc

al D

efic

it (%

GD

P)

Fiscal Deficit (% GDP) for similar Emerging Markets

Source: FRBM Review Committee ReportInfoSphere

Constrained monetary policy and

fear of rising inflation

Adverse impact on yields on

Government Bonds, increasing Interest

Rates

Creates a situation of Fiscal Dominance and High Debt-to-

GDP Ratio

Debt at an average of 70% of GDP, higher than recommended level of 60% of GDP

Post COVID-19 Unemployment

increases, Industries came under stress and Growth declined. A

requirement to spend as counter cyclical

measure

Debt estimated to rise to 85% of GDP

(Moody’s) and future government spending

restricted.

Increased revenue deficit in turn expands Fiscal

Deficit

High Revenue Expenditure by the

GovernmentWhy is India’s Debt

so high?

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STRUCTURE OF PUBLIC DEBT IN INDIA

Public Debt

Internal Debt

Marketable SecuritiesGovernment Securities and Treasury Bills

Non-Marketable Securities

Small Savings, State Provident funds,

reserve funds, state deposits

External Debt

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COMPOSITION OF PUBLIC DEBT

IN INDIA

• Internal Debt for Government of India largely consists of dated securities and treasury bills up to 364 days of maturity.

• The share of Marketable instruments constitutes

• 78.7% of Public Debt

• 68.8% of Total Liabilities

at end-March 2019.

To know more:

https://dea.gov.in/sites/default/files/Status%20Paper%20on%20Government%20Debt.pdf

https://m.rbi.org.in/Scripts/PublicationsView.aspx?id=14939

Source: RBI

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(As

a %

of G

DP)

Domestic and External Liabilities of Centre (as a % of GDP)

Domestic liabilities of Centre External liabilities of Centre

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COMPOSITION OF PUBLIC DEBT IN INDIA

-20%

0%

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60%

80%

100%19

90-9

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(As

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l Def

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Financing of Fiscal Deficit

External finance Market borrowings Other borrowings Draw down of cash balances

Source: RBIInfoSphere

FISCAL DEFICIT AND MARKET BORROWINGS

Financial Crisis (2007-08)

• RBI had a tight liquidity situation that was eased by raising foreign exchange by enabling public sector oil marketing companies to sell oil bonds to RBI.

• However, due lack of liquidity in oil bonds, RBI had to intervene by creating reserve money.

Taper Tantrum (2012-13)

• The size of the government’s net market borrowing program (dated securities) increased nearly 9.7 times in eight years to Rs.4.9 trillion in 2012-13.

The sheer amount of borrowings could still put pressures on monetary policy.

To know more: https://m.rbi.org.in/Scripts/PublicationsView.aspx?id=14939

Source: RBI

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In C

rore

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s.)

Changes in Market borrowing FD

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INFLATION AND PUBLIC DEBT

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(in %

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WPI and Market Borrowings

Changes in Market borrowing WPI

Higher Fiscal deficit

Higher borrowings

Higher interest rates

Reduces Private sector investment (crowding out)

Pushes price levels up

Source: RBIInfoSphere

RESERVE MONEY AND

MONETIZATION

• As of March 2019, RBI owns 15.30% of G-secs.

• A portion of G-secs is held by the RBI. Increases in ownership due to debt financing, can invariably lead to monetization through the secondary market.

• Government deficit leads to incremental reserve money creation, even without auto monetization.

Source: RBI

Increase in reserve money

Expansion in money supply

Inflation

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Per C

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In c

rore

s (R

s.)

Changes in Market borrowing Changes in Reserve Money WPI

Source: Investing.comInfoSphere

• The first announcement to conduct special OMOs was in December 2019.

• However, after the budget announcement in February 2020, the 10-Year bond yields fell sharply.

• The RBI backed the fall in yields by announcing the revised liquidity management framework.

• The 10-year bond yields fell further post the announcement to 6.5%.

• It was the combination of the policy easing and the liquidity measures that caused yields on G-Secs to drop to their lowest level in more than a decade.

To know more: https://m.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=19658#B1

OPEN MARKET OPERATIONS (OMO) AND COVID-19 CRISIS

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Government Security Yields

10Y 3Y

CONCLUSION

• In India, traditionally, a large amount of debt was monetized, and fiscal domination left very little space for monetary policy to manoeuvre and private investment.

• Even today, India has failed to stay fiscally disciplined. In the wake of the Covid crisis and lockdown measures imposed, the limited fiscal capacity of the government has left the economic condition far worse, giving the government limited options to increase spending and boost economic activity.

• The Central bank (RBI) to mitigate the situation has extended liquidity into the economy while provoking capital flight, inflationary pressures and other negative reactions.

• The G-Sec market has remained resilient and stable owing to targeted interventions from the Reserve Bank comprising outright OMO purchases of ₹1.61 lakh crore and other long-term operations. However, as long as RBI keeps government bonds on their balance sheet, a part of government debt will be explicitly monetized.

• Subdued fiscal response when aggregate demand has slumped and resorting more to monetary measures might only worsen the debt-to-GDP ratio of the country. Hence, more fiscal-monetary policy coordination is required to scale up the policy responses to recover from the crisis and achieve economic stability.

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Results of the regression analysis conducted:

Back

The regression is of debt square and revenue deficit on GDP growth rate. The choice of variables are from the regression done bythe FRBM committee report 2017. These variables show that India has taken policy to improve its GDP growth while undermining the sustainability of this growth in the long run.

For any inputs, comments or clarifications please contact The Centre for New Economics Studies at cnes@jgu.edu.in.

Thank you!

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