Mounting debt burden is cause for worry

The International Monetary Fund has, in its recent report, raised a concern about India’s sovereign debt, i.e., the total debt burden on the Union plus state governments. The IMF said that in the next four years, this debt could exceed 100 per cent of the national GDP. This is a worst-case scenario, according to IMF projections.

The government has firmly rebuffed this warning, saying that India’s debt ratio has actually declined from 88 per cent to 81per cent in the past two years. And the Union government is determined to bring the fiscal deficit down to 4.5 per cent in the next two years. 

When we have high deficits, it forces the government to borrow, to bridge the gap. That extra borrowing every year adds to the already high debt mountain. When debt is high, the annual interest payment is also high. This is called the debt-servicing ratio. 

Just to keep servicing the debt, i.e., paying interest only, is costing the Union government nearly Rs 10 lakh crore. This is much higher than the amount collected as individual income tax or corporate income tax (roughly Rs 7 lakh crore each). Interest payments went up by a whopping 38 per cent in the past two years. The interest payment alone is the single largest component of the government’s expenditure, consuming one-fifth i.e., 20 per cent of all its obligations. 

Since the interest burden is high, that causes the deficit to go up, which in turn causes the debt to go up, which causes the interest burden to keep increasing. This can lead to what is called the debt trap. It is like borrowing just to keep paying interest.

When is the government going to decrease the mountain of debt? That can happen only when the tax revenues rise faster than expenditure. Indeed, this has been happening lately, both in income tax as well as indirect taxes (GST, chiefly). This has happened partly because the tax laws have plugged many loopholes in the past few years. For instance, long-term capital gains tax was zero. Capital gains, i.e., profit made by selling stocks or real estate, are not completely tax exempt as they used to be. The Mauritius tax treaty had a loophole which was plugged a few years ago. 

But much work is still needed to increase India’s tax collection-to-GDP ratio, which is currently around 17 per cent of GDP. This is at least three to four percentage points lower than the median for all emerging market economies. So, India is undertaxed as far as direct taxes are concerned, a fact that was mentioned in the Economic Survey published by the Union Finance Ministry. However, the indirect tax burden is increasing, given that the median rate of GST is still very high at 18 per cent. 

But let us go back to the issue of India’s debt sustainability. One of the counterpoints raised by the government in response to the IMF report is that other countries like the US and UK have much higher debt-to-GDP ratios.

What this fails to mention is that most rich country debts (including all of the 15 OECD economies) have high debt-to-GDP ratios because of their very high social security obligations. In all these countries, all elderly citizens get a pension, and all of them are entitled to free healthcare.

These government obligations are met with payroll taxes on working people. But since these rich countries are ageing, and the average age is much higher than India, the payroll taxes are insufficient to meet social security obligations.

In Germany, for instance, the dependency ratio is one is to three, i.e., there are only three working people for every one retired person. Hence the rising debt of rich countries is predominantly because of rising (and perhaps unsustainable) social security obligations.

In the case of India, there is hardly any social security payment. Those covered currently are under the Old Pension Scheme. It is unfunded, and comes from current revenues. It is restricted to pensions paid to people who retired from government service or the military.

That OPS pension is quite generous. However, that goes to only 3 per cent of the workforce. The pension plus salaries of government servants will soon be nearly 27 per cent of revenues, as per the projections of a report of the government of Andhra Pradesh. So, it is unfair to defend India’s 80-90 per cent debt ratio with comparisons to the US or UK’s 140-150 per cent because the latter is based on those governments’ social security payments to their ageing societies.

What’s in India’s favour are two points: Firstly, much of the debt is in domestic currency, so no heavy foreign currency obligations arise on the government. Secondly, India’s workforce is young and the dependency ratio will be favourable, for at least three decades. We have more than five working persons for every one retired person. But our per capita income of workers is low. And we will find it difficult to impose higher payroll taxes. Hence the New Pension Scheme (NPS) in place since 2005 takes away the burden from the government. 

Despite the two factors in India’s favour, we have to be seriously worried about the sustainability of our debt. The government’s interest payment burden as a proportion of the annual expenditure is too high. We have a large stock of capital under government ownership which is not giving any significant returns. That must be passed on to private ownership wherever possible. We have to examine the effectiveness of expenditures and remove waste and duplication. At the same time, India has to spend considerably more public funds on enhancing human capital, i.e., on primary healthcare and primary education. Also, there is a need to fund research and innovation via public universities. So, while GDP growth is good, we must focus on how to make the debt situation more sustainable, by narrowing the gap between expenditure (28%) and tax revenues (17 per cent) as well as increasing the efficacy of our expenditures, and increasing revenues.

(The writer is a noted economist) (Syndicate: The Billion Press)