As 2021 dawns, all eyes will be turned towards the annual exercise of balancing the Centre’s books in the Union Budget. One factor that will be hard to brush aside this year is the burgeoning debt of the Centre and the States.
The sharp hit to the economy in the June 2020 quarter and the slowdown in the September quarter has caused a sharp contraction in revenue while expenditure has mounted due to the stimulus measures. This is expected to increase the fiscal deficit of the Centre and the States to 13.1 per cent of the GDP in FY21 from 8.2 per cent in FY20. The borrowing of both the Centre and the States has been hitting the roof, in order to bridge the gap.
The problem is that the growing debt pile and increasing interest expense had been a problem for some time now, with consecutive governments kicking the can down the road in the hope that it will be someone else’s problem. But given the negative fallout of the debt burden in constraining constructive capital spending and increasing the borrowing cost in the economy, it is taking a toll on growth.
A persisting problem
Market borrowing for the next fiscal attracts a lot of discussion every year. But it needs to be noted that this amount is in addition to the already existing liabilities. Outstanding liabilities of the Centre — which include market borrowing, external assistance, securities against small savings, State Provident Fund and so on — have been increasing in double digits in most years, since 2013. From total debt of ₹50.71 lakh crore in March 2013, liabilities have now increased beyond ₹106 lakh crore by November 2020.
State governments have also been increasing their outstanding liabilities at similar rate. From ₹22.45 lakh crore in FY13, total borrowing of States in Budgeted to increase to ₹59.89 lakh crore by FY21.
The interest cost of this large debt is creating a big dent in the Budget too. Interest payments have been the largest component of the Centre’s revenue expenditure, ranging between 26 to 30 per cent, since 2017; interest cost of States accounted for 11 to 12 per cent of their revenue expenditure in the same period.
Made worse by the pandemic
Further, the devastating effect of the Covid-19 has taken the debt of the Centre and States to unprecedented levels. Net market borrowing of the Centre in the April-September 2020 period was ₹7.74 lakh crore, accounting for 142 per cent of the budget estimate for FY21 and 75 per cent higher than the corresponding period of the previous fiscal years. The States were allowed higher borrowing of an additional 2 per cent of GSDP in May 2020, as a result of which States’ net borrowing has increased ₹3.81 lakh crore in the first half of FY21, amounting to 68 per cent of the Budget estimate.
There are two interesting points to note in the first half borrowing — the Centre’s borrowing amounting to 13 per cent of the GDP was higher than the fiscal deficit of 10.7 per cent of the GDP in the first half of FY21, pointing towards front-loading of the borrowing. Two, almost all the borrowing was through the market, unlike previous fiscals.
A debt trap in the making
With the Centre and States consistently showing a gross fiscal deficit year after year, the total debt burden has only increased. The worrying part is that the government is now having to borrow to repay the loans that mature, rolling over the existing loans, thus ensuring that the total liability does not reduce at all. The government is also taking on additional loans to service the interest cost, creating a classic debt trap.
The immediate consequence of this situation is on the bond market. While the reverse repo rate is currently at 3.35 per cent, the 10-year G-Sec is trading at 5.9 per cent despite the RBI’s measures such as Operation Twist, allowing banks to hold a larger portion of bonds in held-to-maturity bucket and so on. It’s obvious that bond markets are worried about the fiscal deficit that is expected to remain elevated at least for two more years. These yields have an impact on the rate at which companies borrow from the bond market, thus keeping borrowing cost elevated in the economy.
The other significant problem with the large borrowing is that it is resulting in reduction in capital expenditure. The RBI had recently pointed out that both the Centre and States have resorted to capex cuts in 17 years and 16 years respectively, over the last two decades. But in the last few years, the capex cuts had been sharper in States.
Arguing that India is in similar straits as the US or the EU as far as government debt goes is not correct. The borrowing cost is close to zero in these countries and there is a large demand for their debt securities. Also the wealth of these countries allows them to print notes with abandon, a luxury that India does not enjoy.
What’s the way out
The decline in government bond yields — from 8.51 per cent in FY15 to 5.85 per cent in FY21 — has provided some relief. The lower proportion of external debt and the average maturity of the outstanding stock of government securities at 10.75 years also provides some comfort. But the government needs to start thinking seriously about reducing this debt pile.
Spending one-third of the revenue expenditure on interest cost results in curtailing other revenue spends which can help spur consumption. The other big component of revenue expenditure — subsidies — that has 12 per cent share also needs to be rationalised and restricted to the most needy sections. Besides these, the freebies doled out from time to time including farm loan waivers and electricity subsidies etc need a review too.
The pandemic-related disruption has given the Centre the opportunity to go back to the drawing board and fix the fundamental flaws in its Budgeting exercise and address the looming debt trap.