The Hindu : Does India face a debt trap?

Online edition of India's National Newspaper
Monday, Jan 26, 2004

Business

Business

Does India face a debt trap?

IT WOULD seem odd to talk about a debt trap when the economy is doing well and the macroeconomic signs are good. But a little reflection will show that this not an irrelevant issue.

A crucial driving force of modern economies is the spending by individuals, companies and the government. Another feature is the borrowing to finance this spending. We live in an age of credit cards, corporate borrowing and government budgetary deficits. It is necessary to examine the limits to such borrowing and see whether there are risks of running into debt traps.

The volume of credit card debt is substantial in developed economies with the attendant concerns over individual savings and solvency and the ineffectiveness of monetary policies of central banks to control such credit. Use of credit cards in India has not reached such a level to merit concern. Corporate borrowing is a legitimate tool for business expansion and the imperatives of profitability and market value of company shares can be expected to channel the borrowed funds into productive use and keep the debt sustainable (Imprudent corporate lending by banks is a separate issue involving many factors). This shifts the focus of attention to the debts incurred by the Union Government.

Public debt or government debt has special features which make it all the more important to study its sustainability. Public expenditure grows inexorably often due to political compulsions and is not always based on priority or productive schemes and projects. Revenue mobilisation, tax and non-tax, is a huge and unpalatable task. The resultant spiral of deficit and debt run the risk of undermining the country's creditworthiness, devaluing the currency and destabilising the entire economy and the society. In contrast, while imprudent private debt will ruin individuals and companies it may not have any macroeconomic effect.

External public debt of India was $101.97 billion in September 2002 and amounted to 20.1 per cent of the GDP. The debt servicing burden was 13.8 per cent of current receipts in 2001-02. This is a comfortable position when compared to countries which have run into debt problems. The component of short term debt too has been declining, easing the repayment schedule. The external balance has significantly improved and foreign exchange reserves now exceed $100 billion or one year import requirements. After 24 years there was a current account surplus in 2001-02 (The deficit in the first quarter of the current year does not vitiate the overall stable external position). In fact, India has recently become a creditor to the International Monetary Fund. According to all indicators, India does not have any problem with its external public debt. This has been recognised even by credit rating agencies like Moody's which has upgraded India's foreign currency debt rating recently. However, the country's internal public debt presents a different picture. The salient indicators are flashing red:

— Continuous and sharp rise in budgetary deficits and consequently internal public debt. The size of the Central Government's debt was Rs. 2,865 crores at the end of 1950-51, Rs. 1,021,029 crores in 1999-2000 and an estimated Rs. 17,80,063 crores in 2003-04. Adding State government borrowings, the total debt exceeds the GDP.

— The combined budget deficit of the Central and State governments in 2003-04 will be more than 10 per cent of the GDP.

— The debt servicing bill of the Centre in 2003-04 will be Rs. 288,599 crores and out of this, interest payments will take away 50 per cent of the revenues.

— A major part of the borrowings go to meet current consumption expenditure such as salaries, pensions and interest payments and do not add to capital assets. This is due to poor revenue collections which are inadequate to cover even routine expenditure.

— The tax-GDP ratio shows a declining trend from 16 per cent in 1999-2000 to an estimated 14 per cent in the current year.

It is true that the Government has not defaulted on any of its payment obligations. But the threat of a debt trap is to be examined over the medium and longer time span. All the indicators reveal a trend of growing mismatch between revenue and expenditure and the resultant mismatch between increase in fiscal deficits and the capacity to service the growing debts without jeopardising growth. If the present sluggishness in revenue mobilisation and uncontrolled, unproductive and inefficient spending continue, public debt is likely to pose a problem in the medium term. However, the country can still avoid such a contingency if it acts now to correct the fundamental weaknesses in the fiscal policy and management. The recently enacted Fiscal Responsibility and Budget Management Act provides an opportunity to address these. It is hoped the rules to be framed under the Act will provide the medium term perspective for the fiscal reform. Specific items for the reform and follow up action needed were detailed in an earlier article by this author (June 23, 2003). The Chairman of the Twelfth Finance Commission, in a recent seminar organised by the National Institute of Public Finance and Policy on the issues before the Commission, has called for scaling down of the deficit and debt problem. The Commission's recommendations on fiscal consolidation can help the reform process. here is growing concern over budget deficits even in developed countries like the U.S., the U.K. and France though the specific causes and cures are different in these cases.

A. Rangachari

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