Internal Public Debt, Growth and Composition of
INTERNAL PUBLIC DEBT, GROWTH AND COMPOSITION OF
INTERNAL PUBLIC DEBT, GROWTH AND COMPOSITION OF The uninterrupted and rapid growth of India's public debt has been a matter of serious concern. An increasing debt servicing burden and its feedback into further deficits and debt have raised apprehensions about sustainability and solvency. Its adverse impact on economic growth by crowding out private investments has also been a matter for concern. Government finances deteriorated and deficits emerged in the revenue (current) account in 1982, and its rapid increase since has caused India's central government to employ public debt mainly as an instrument to transfer private savings into public consumption and public investment, a considerable proportion of the latter being unproductive. Increasing indebtedness has raised questions about sustainability, and has dampened the growth prospects of the economy by crowding out private investment.
The growth of government indebtedness can be viewed in relation to the development strategy and economic environment in the country, and four distinct phases in the trend can be discerned. Initially, government borrowing was meant to finance public sector investment in keeping with the development strategy of India's first few Five-Year Plans. Thus, public debt as a ratio of gross domestic product (GDP) increased from 30 percent in 1950–1951 to 36 percent in 1960–1961, remaining broadly at that level until 1964–1965. However, inability to generate public savings required financing further public sector investments, initiating the economic recession of 1965, which forced a suspension of the plan from 1966 to 1968. Subsequently, in the second phase, government indebtedness declined sharply to 26.8 percent of GDP until 1975. The third phase saw the rapid increase in public debt, particularly after 1984–1985. The debt to GDP ratio increased from 37.6 percent in 1980–1981 to 45 percent in 1984–1985 and further to 56.7 percent in 1990–1991. The fiscal expansion in the latter half of the 1980s, and the consequent sharp increase in primary and revenue deficits at both central and state levels resulted in the rapid increase in the debt-GDP ratio. The buildup of fiscal expansion in the 1980s and the persistent fiscal imbalance caused macroeconomic imbalance, creating a crisis in 1991. Thus, the fourth phase in public debt began with fiscal containment, which was, however, short-lived. The inability to contain government expenditures on the one hand and a declining tax-GDP ratio at the central level on the other resulted in the sharp increase in government indebtedness, bringing to the fore serious questions of debt sustainability and solvency.
The increase in indebtedness over the years is due to both central and state governments. The total outstanding debt attributable to the states increased from about 10 percent in 1950–1951 to over 25 percent in 2001–2002. Thus over a quarter of the internal public debt incurred in India is for the state governments, and the remainder is for New Delhi's central government.
The internal debt of the government consists of outstanding loans from the market and other outstanding liabilities. Within the latter, deposits in provident funds, post office savings, and other small savings collections constitute the bulk. Analysis shows that the proportion of other outstanding liabilities has steadily increased over the years, from about 25 percent of total outstanding liabilities in 1950–1951 to over 40 percent in 2001–2002. Transferring private savings for public investment within the regime of financial repression was an inherent part of the planning strategy. Thus, during the first four decades, the interest rate on market borrowing by the government was fixed at substantially below the market rate, and commercial banks were required to invest a significant portion of their lendable resources in government securities as a statutory liquidity ratio.
Traditionally, part of the budget deficit was financed by loans from the Reserve Bank of India. The proportion of such deficit financing increased from 16 percent in the early 1970s to nearly one-third during the latter half of the 1980s. This resulted in unplanned growth in the public debt. The economic crisis of 1991 raised serious questions about the means of financing budget deficits, and in 1995 an agreement was reached between the Reserve Bank's governor and the finance secretary of the government of India to completely dispense with the practice of monetizing the deficit.
The high and increasing volume of debt raised serious questions of stability and sustainability, and had a dampening effect on economic growth. As much of the borrowing is undertaken to finance current expenditures of the central and state governments, it does not generate direct or indirect returns to the government to meet debt-servicing obligations. Thus, additional borrowing has to be resorted to, and this vicious cycle creates imbalance between savings and investments and spills over into the balance of payments problem. The simple test of sustainability is given by the Domar rule, according to which debt is sustainable as long as the interest rate is lower than the growth rate of the economy. In India, the interest rates were deliberately kept low, and therefore there was no danger of their exceeding the growth rate until the interest rate regime itself was liberalized. Nevertheless, effective interest rates steadily increased from 2.3 percent in 1951–1952 to 5 percent in 1970–1971, to 7.6 percent in 1990–1991, and finally to over 10 percent in 2001–2002. Recent careful analysis of the central government debt shows that the interest rate has been higher than the growth rate of the economy both in 2000–2001 and 2001–2002.
Thus on the one hand, the volume of borrowing has increased at over 20 percent per year since 1991–1992, and on the other, the effective interest rate has shown a sharp increase following the financial liberalization. The effect is rapid increase in debt servicing costs, feeding back into further borrowing. Recent lowering of interest rates and acceleration in growth rate may hold back the growth of indebtedness, but the high volume of borrowing to finance large fiscal deficits continues to be a matter of serious concern. Fiscal consolidation is perhaps the key required to arrest further rapid growth of India's internal indebtedness.
M. Govinda Rao
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