Ideally, debt servicing should be resolved internally and receipts like divestments can be used to partly finance such redemptions. even options like spectrum sale can be used.
Whenever we speak of the Budget, there is an obsession with the fiscal deficit number to the extent that the edifice of any such document is built around this ratio (expressed as % of GDP). Foreign agencies also harp on the debt level, which leads to controversies on what should be included or excluded from the concept. But, the final deficit number of 3%, or 3.3%, or 3.5%, becomes the benchmark for evaluating the efficacy of the budget, and there are several critiques on the quality of such spending.
There is a sense of relief and satisfaction when we move towards this number. But is this the ‘be all and end all’ of budgets?
One aspect of the budget that has missed attention over the years has been the debt-trap, mainly because we were well away from this pitfall for quite some time. Further, the FRBM rules never speak of this concept, because, somewhere along the way, this idea has been given a miss. One of the reasons could be that since money is fungible, it is hard to say what part of the budget’s resources is used for financing development/non-development expenditure, or to repay the debt. But intuitively, if the debt servicing component of the government approached the gross borrowing number, then it results in a fiscal debt trap (FDT).
This concept is important because even while the prudent debt measures are maintained through some adept statistical handling, additional borrowing reckoned in time period ‘t’ has to be serviced through the years, until it is redeemed. Hence, larger quantities borrowed today would have to be serviced continuously, and add to the debt servicing cost. Progressively, governments have been elongating the borrowing time liability through issuance of longer term tenures of debt and often switched debt to ensure that bunching up does not take place. But, debt has an interest component, which has to be paid every year and increases rapidly over time.
In the last 10 years, for instance, gross borrowings of the government has increased at a CAGR of 3.9%, while interest payments have risen by 11.7%. As a result, the debt servicing component has increased sharply. In fact, the share of interest in overall size of the budget has been above 20%, which implies that a fifth of the budget is committed to the service aspect. Add to this, the redemption of loans, and the outflow can get quite substantial.
The accompanied table gives the FDT numbers over the years. Data is provided for the gross borrowings of the central government, interest payments, and the ratio of government debt servicing to borrowings calculated in two ways. FDT-1 takes into account normal redemptions, while FDT-2 includes also the switches that have been made during the year.
Interest payments have increased by around 2.7 times during this period, which is also the rate at which the normal redemptions have increased. Adding the switches to debt redemption increases the multiple to 4.5 times. Hence, the divergence between the FDT-1 and FDT-2 becomes stark after 2015-16, and has now peaked at 129% of borrowings in 2018-19. Even under the debt servicing, including only normal redemption, 2016-17 was the cutoff year when the ratio of 100% was crossed.
An FDT is significant because it underscores the fact that debt servicing has become a major burden for the government, and that the overall borrowings are not able to cover this aspect of debt servicing. This, in fact, puts more pressure on the revenue collections to meet other commitments like salaries, subsidies, defence expenditure and capex. The ability to increase these components, or those outside this circumference, will depend on higher revenue being generated.
This aspect of debt also needs to be looked at when working on the fiscal deficit and outstanding debt numbers. The debt servicing component will keep increasing over time as with longer maturities of government debt, interest payments will keep getting higher in magnitude. With upwards of `51 lakh crore of debt to be serviced every year, this pressure will keep increasing, and put pressure on the fiscal space.
Ideally, debt servicing should be resolved internally and receipts like disinvestments can be used to partly finance such redemption. Going ahead, even options like spectrum sale can be used for making redemptions. This would ensure that there is less pressure on the regular flows of revenue. Unfortunately, disinvestment is being used today to shore up the budgetary balances, and lower the fiscal deficit and, hence, borrowing programme. Hence, while the gross borrowing programme has been contained in the region of `6-6.25 lakh crore in the last five years, the progressive interest cost and redemption have pushed the government further into the debt trap.
There can, hence, be argued a case for lowering the size of the government expenditure in order to address this issue of debt trap, whereby resources are earmarked for addressing the issue of redemption and other channels used for making the interest payments like RBI surpluses, PSU dividends, etc. This is a tough call, given that the central government appears to be the only entity that has been spending on infrastructure in the last three years in three critical areas—roads, railways and urban development—where private investment is not forthcoming. A tradeoff exists.
Going ahead, as part of fiscal prudence, the government has to focus also on debt servicing. The narrow triangle of revenue deficit, fiscal deficit and debt-to-GDP ratio is passé as the concept of already being in a fiscal debt trap is scary—if the same of states is also added, the picture could look even more grotesque.
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