The festival season may have masked underlying fears for our economy, and our equity markets may have rebounded amidst pandemic woes, but a looming worry is that Covid-19 will distort India’s Debt : GDP ratio to record high levels. As per Moody’s, amongst large emerging markets, India will have the highest debt burden by FY 21. A fall in tax revenue due to depressed economic activities coupled with an increase in public spending is expected to cause a steep 17 % points rise in India’s Debt : GDP ratio, stretching it to nearly 90%. That should ring alarm bells for policy makers.
India has consistently maintained a stable Debt : GDP at ~70% over the past decade. With real GDP growth rate hovering around 6.5% between 1991 to 2013, India has successfully lifted millions of people from extreme poverty and has grown its real GDP per capita by over 4X during that period. Over the years, India has made astonishing progress in many areas including Education enrollment, Infant mortality, access to clean water and sanitation and has achieved the millennium development goal of halving poverty by 2015 from 1991 level.
As the pandemic deteriorates fiscal dynamics, India is expected to shave off the progress it made over the years as the country’s overall debt is set to tailspin to an unmanageable level. The World Bank reports that Debt : GDP above 77% can significantly impact the long-term growth rate of a country, its credit ratings which in turn may affect foreign funds inflows. A rising Debt : GDP ratio can at times have more severe consequences to the country’s sovereign rating compared to the fiscal deficit ratio. India is already at a negative outlook at Baa2. Any further increase in Debt can translate into widening the gap between India and other countries rated in BBB category which have a median Debt : GDP ratio of 42%. Our government introduced Fiscal Responsibility and Budget Management (FRBM) Act in 2003 and adhered to the caps set in there on Fiscal Deficit (~ 5% of GDP) and Debt : GDP ratio (60%), which now seems to be unravelling.
Government should spend, but how?
Despite concerns about the economy and growing debt levels, a possible silver lining exists for India. The country’s overall external debt increased from USD 345.8 Bn in 2012 to USD 558.5 Bn today. However, India also increased the share of INR denominated external debt from 21.4% in 2012 to 31.9% in 2020. A higher proportion of debt denominated in INR helps India mitigate its forex risk.
Also, India is blessed with record high foreign exchange reserves which are sufficient to meet any current external debt obligations. Sustainable external debt levels largely depend on the…
