Introduction
Public debt refers to the total liabilities (internal and external) of the central government, contracted against the Consolidated Fund of India. It represents the accumulation of past government borrowings to finance budget deficits. Understanding public debt is crucial as it has significant implications for a country's economic stability, growth, and inter-generational equity.
This note will delve into the sources, components, sustainability, and management strategies of public debt, with a special focus on the Indian context and recent trends.
Core Concepts of Public Debt
7.2.1. Sources of Public Debt: Internal vs. External Debt
Public debt can be broadly classified based on the source of borrowing:
Internal Debt
Definition: That part of the public debt borrowed from individuals, institutions, and commercial banks within the country. (Source: IGNOU, Public Finance; Ramesh Singh, Indian Economy)
Pros:
- Reduces dependence on foreign creditors.
- Minimizes exchange rate risk.
- Interest payments remain within the country, potentially stimulating domestic demand.
- Can be managed more effectively through domestic monetary policy.
Cons:
- Can lead to "crowding out" of private investment if it absorbs a large share of domestic savings. (Source: NCERT Class 12 Macroeconomics, Chapter 5)
- Can be inflationary if financed by printing money (monetized deficit, though restricted in India under FRBM).
External Debt
Definition: That part of the public debt borrowed from foreign governments, international financial institutions (like World Bank, IMF, ADB), and commercial lenders outside the country. (Source: IGNOU, Public Finance; Ramesh Singh, Indian Economy)
Pros:
- Supplements domestic savings and provides access to foreign capital.
- Can finance critical imports and technology.
- Often comes with longer maturity periods and concessional terms (especially from multilateral agencies).
Cons:
- Exchange Rate Risk: Repayment amount (principal and interest) increases if the domestic currency depreciates.
- Sovereign Risk: Risk of default can affect the country's international credit rating.
- Conditionalities: Loans from international institutions may come with policy conditionalities.
- Interest payments lead to an outflow of domestic resources.
Summary Table: Internal vs. External Debt
| Feature | Internal Debt | External Debt |
|---|---|---|
| Source | Domestic (individuals, banks, institutions) | Foreign (govts, intl. orgs, foreign banks) |
| Currency | Domestic Currency | Foreign Currency (mostly) |
| Risk | Lower exchange rate risk, potential crowding out | Higher exchange rate risk, sovereign risk, conditionalities |
| Dominance (India) | High | Relatively Low |
7.2.2. Components of Public Debt: Marketable vs. Non-Marketable Securities
Public debt, especially internal debt, can be further categorized based on its marketability:
Marketable Securities
Definition: These are financial instruments that can be freely bought and sold in the secondary market before maturity. (Source: RBI website)
Non-Marketable Securities
Definition: These securities are not tradable in the secondary market and are typically held until maturity or can be encashed with the issuer. (Source: IGNOU material)
Summary Table: Marketable vs. Non-Marketable Securities
| Feature | Marketable Securities | Non-Marketable Securities |
|---|---|---|
| Tradability | Freely tradable in secondary market | Not tradable, held till maturity |
| Examples | G-Secs, T-bills, Cash Management Bills (CMBs) | Small Savings (NSC, KVP), Special G-Secs to NSSF |
| Price | Market-determined | Administered/Fixed |
| Liquidity | Higher | Lower |
7.2.3. Debt Sustainability: Impact on Economy
Definition: A situation in which a government can meet its current and future debt servicing obligations without requiring exceptional financial assistance or resorting to default. It implies that the debt-to-GDP ratio is stable or declining over time. (Source: IMF, World Bank)
Key Indicator: Debt-to-GDP Ratio
- A high ratio indicates a significant debt burden relative to the economy's output.
- FRBM Review Committee (N.K. Singh Committee) recommended a target debt-to-GDP ratio of 60% for the general government (Centre and States combined) by FY23 – 40% for the Centre and 20% for States. (Source: Report of the FRBM Review Committee, 2017)
Factors influencing sustainability:
- Nominal GDP growth rate.
- Primary deficit/surplus (fiscal deficit minus interest payments).
- Interest rates on government borrowings.
- Maturity structure and currency composition of debt.
Positive Impacts:
- Financing Public Investment: Debt can finance essential infrastructure and social sector projects, boosting long-term growth. (Source: NCERT Class 12 Macroeconomics)
- Economic Stabilization: During recessions, increased government spending (often debt-financed) can stimulate demand (Keynesian economics).
- Inter-generational Equity (if used for capital formation): Future generations benefit from assets created today.
- Development of Financial Markets: Government securities form the bedrock of the debt market.
Negative Impacts:
- Crowding Out: Large government borrowing can absorb private savings, increasing interest rates and reducing private investment. (Source: NCERT Class 12 Macroeconomics)
- Inflationary Pressure: If debt is monetized (RBI buys government bonds by printing money), it can lead to inflation. (This is now limited by FRBM Act).
- Increased Tax Burden: Future generations may face higher taxes to service the debt.
- Debt Trap: If borrowings are used for unproductive consumption expenditure, the government might have to borrow more just to pay interest, leading to a vicious cycle.
- Pressure on Exchange Rate: High external debt can lead to capital outflows and currency depreciation.
- Reduced Fiscal Space: High interest payments consume a significant portion of government revenue, limiting funds for other development activities. For India, interest payments are the largest revenue expenditure item. (Source: Union Budget documents)
- Inter-generational Inequity (if used for consumption): Future generations bear the burden without corresponding benefits.
Conceptual Flow: Impact of High Public Debt
Increased Borrowing
Government needs more funds.
Higher Interest Rates (Crowding Out)
Competition for funds, reduces private investment.
Reduced Fiscal Space
More revenue for debt servicing, less for development.
Inter-Generational Inequity
Future generations bear the burden.
7.2.4. Debt Management Strategies
Effective debt management aims to ensure that the government's financing needs and its payment obligations are met at the lowest possible long-run cost, consistent with a prudent degree of risk.
Ministry of Finance (MoF)
- Cornerstone of India's fiscal consolidation and debt management.
- Mandates limits on fiscal deficit, revenue deficit, and total debt. (Source: Laxmikanth, Indian Polity; Ministry of Finance)
- Amended and targets revised based on N.K. Singh Committee (2017) for flexibility.
- Aims for inter-generational equity and long-term macroeconomic stability.
Reserve Bank of India (RBI)
Operational Aspects:
- Conducts auctions for T-bills and G-Secs.
- Manages registry and depository for government securities.
- Develops the government securities market.
- Advises government on new loans.
Strategies Employed:
- Elongation of Maturity Profile: Issuing longer-tenor bonds to reduce rollover risk.
- Development of Secondary Market: Enhancing liquidity for G-Secs.
- Diversification of Investor Base: Encouraging retail investors, insurance, pension funds (e.g., RBI Retail Direct Scheme).
- Active Consolidation: Reissuance of existing securities to improve liquidity.
- Buyback of Securities: Prematurely buying back G-Secs to manage liquidity or reduce debt stock.
Current Trends & Borrowing Program
Debt-to-GDP Ratio: A Visual Trend
Prelims-Ready Key Points
Public Debt
Total liabilities of the central government.
Internal Debt
Borrowed from within the country. Dominant in India. Less exchange rate risk.
External Debt
Borrowed from outside the country. Carries exchange rate risk.
Marketable Securities
Tradable (G-Secs, T-bills, CMBs). Price discovery via market.
Non-Marketable Securities
Not tradable (NSC, KVP, Special G-Secs to NSSF). Administered rates.
Debt Sustainability
Ability to service debt without default. Key: Debt-to-GDP ratio.
FRBM Act, 2003
Aims for fiscal discipline, sets targets. N.K. Singh Committee recommended 60% general govt. debt-to-GDP.
Debt Management
MoF (overall policy, PDMC), RBI (operational management, auctions).
Crowding Out
High govt. borrowing raises interest rates, reduces private investment.
India's Debt (FY24 BE)
Union Govt: ~57.1% of GDP. General Govt: ~81% (IMF, FY23).
Sovereign Green Bonds
Issued by GoI to fund green projects.
Global Bond Index
India's G-Secs to be included in J.P. Morgan GBI-EM Index from June 2024.
Mains-Ready Analytical Notes
Optimal Level of Public Debt:
- No universally agreed "optimal" debt-to-GDP ratio; varies based on country's economic structure, growth potential, institutional quality, and global conditions.
- Pro-higher debt (during crises/for investment): Keynesian view supports borrowing for counter-cyclical fiscal policy and for productive investments (infrastructure). If growth rate (g) > interest rate (r), debt can be sustainable.
- Con-higher debt: Leads to higher interest burden, crowding out, potential for default, inter-generational inequity. Classical economists emphasize fiscal prudence.
- N.K. Singh Committee (FRBM Review): Advocated for a sustainable debt path, setting a 60% target for general government debt by FY23, acknowledging flexibility via "escape clauses".
Crowding Out vs. Crowding In:
- Crowding Out: Government borrowing increases demand for loanable funds, raising interest rates and reducing private investment.
- Crowding In: Public investment in infrastructure and human capital can improve productivity and create new investment opportunities for the private sector. Relevant for developing economies with infrastructure gaps.
Effectiveness and Flexibility of FRBM Framework:
- Pros: Instilled fiscal discipline, improved transparency, credible anchor.
- Cons: Critics argue it can be too rigid, hindering necessary public spending during slowdowns. COVID-19 forced significant deviation, highlighting need for flexibility.
Monetization of Deficit:
- Historically, India monetized deficit via ad-hoc Treasury Bills to RBI. Discontinued with 1997 GoI-RBI agreement, formalized under FRBM Act (barring escape clauses).
- Pros (extreme situations): Immediate financing.
- Cons: Highly inflationary, erodes RBI's independence, macroeconomic instability.
Pre-1991
Higher reliance on statutory liquidity ratio (SLR) for banks to finance government debt at administered interest rates. Monetization of deficit was common.
Post-1991 Reforms
Move towards market-determined interest rates for government securities. Phasing out of automatic monetization. Development of primary and secondary markets for G-Secs.
FRBM Era (Post-2003)
Focus on fiscal consolidation. Debt-to-GDP ratio declined from 61.7% (Union Govt.) in 2002-03 to 46.5% in 2014-15 before rising again.
Recent Trends (Post-COVID)
- Significant rise in public debt due to pandemic-related fiscal stimulus and revenue shortfall.
- Increased focus on elongating maturity profile of debt.
- Active debt management by RBI to ensure smooth passage of large government borrowing programs.
- Introduction of new instruments like Sovereign Green Bonds.
- Efforts to widen investor base (e.g., RBI Retail Direct).
- Confirmation of inclusion in global bond indices (September 2023), integrating India's debt market more closely with global finance.
- Macroeconomic Stability: Sustainable public debt is crucial for maintaining price stability, investor confidence, and a stable exchange rate.
- Fiscal Space: High debt servicing costs reduce the government's ability to spend on essential services and development projects. India's interest payments/revenue receipts ratio is high (estimated at 42.7% for 2023-24 BE), indicating constrained fiscal space.
- Credit Ratings: International credit rating agencies (S&P, Moody's, Fitch) closely monitor public debt levels. High debt can lead to rating downgrades, increasing borrowing costs.
- Monetary Policy Transmission: A well-developed government securities market, which hinges on public debt, is essential for effective monetary policy transmission.
- Infrastructure Financing: Public debt remains a key source for funding India's ambitious infrastructure pipeline.
Real-World Examples & Case Studies
India's COVID-19 Debt Surge
Context: The Union Government's fiscal deficit shot up to 9.2% of GDP in 2020-21, financed largely by increased borrowings, leading to a spike in the debt-to-GDP ratio.
Outcome: Highlighted the critical role of fiscal policy in crisis response and the immediate impact on debt levels. Demonstrated the "escape clause" necessity in FRBM. (Source: Economic Survey 2021-22)
Sri Lankan Debt Crisis (2022)
Context: A cautionary tale of unsustainable debt primarily due to high external debt, reliance on short-term commercial borrowings, unproductive spending, and significant tax cuts.
Outcome: Led to economic collapse, sovereign default, severe social unrest, and a prolonged humanitarian crisis. Emphasizes the dangers of poor debt management.
Sovereign Green Bonds in India
Context: India successfully issued two tranches of Sovereign Green Bonds in FY23, raising ₹16,000 crore for green projects. The framework for these bonds was released in November 2022.
Outcome: Reflects a global trend towards sustainable finance and provides a new avenue for mobilizing resources for environmentally friendly infrastructure development. (Source: RBI, PIB, Jan-Feb 2023)
Japan's High Debt Paradox
Context: Japan has one of the highest public debt-to-GDP ratios globally (over 250%), far exceeding most countries.
Outcome: Despite this, it has not faced a sovereign debt crisis. This is largely because its debt is mostly domestically held, denominated in Yen, and interest rates have been extremely low, illustrating the importance of debt composition and domestic savings.
UPSC Previous Year Questions (PYQs)
Prelims MCQ 1 (UPSC CSE 2018)
Consider the following statements:
- The Fiscal Responsibility and Budget Management (FRBM) Review Committee report has recommended a debt to GDP ratio of 60% for the general (combined) government by 2023, comprising 40% for the Central Government and 20% for the State Governments.
- The Central Government has domestic liabilities of 21% of GDP as compared to that of 49% of GDP of the State Governments.
- As per the Constitution of India, it is mandatory for a State to take the Central Government’s consent for raising any loan if the former owes any outstanding liabilities to the latter.
Which of the statements given above is/are correct?
- (a) 1 only
- (b) 2 and 3 only
- (c) 1 and 3 only
- (d) 1, 2 and 3
Answer: (c)
Hint/Explanation:
- Statement 1 is correct (N.K. Singh Committee recommendation).
- Statement 2 is incorrect; Central government liabilities are much higher than states' combined.
- Statement 3 is correct (Article 293(3) of the Constitution).
Prelims MCQ 2 (UPSC CSE 2016)
Which of the following is/are included in the capital budget of the Government of India?
- Expenditure on acquisition of assets like roads, buildings, machinery
- Loans received from foreign governments
- Loans and advances granted to the States and Union Territories
Select the correct answer using the code given below.
- (a) 1 only
- (b) 2 and 3 only
- (c) 1 and 3 only
- (d) 1, 2 and 3
Answer: (d)
Hint/Explanation: Loans received (2) are capital receipts. Expenditure on asset acquisition (1) and loans granted (3) are capital expenditures. All are part of the capital budget. Public debt (borrowings) is a major component of capital receipts.
Mains Question 1 (UPSC CSE 2019)
Public expenditure management is a challenge to the Government of India in the context of budget-making during the post-liberalization period. Clarify it.
Direction:
Discuss how managing public expenditure (which includes debt servicing) has become complex. Link to FRBM, changing economic priorities, demands for social sector spending, and infrastructure needs. Mention how revenue constraints and the need for fiscal prudence impact expenditure management.
Value Points:
- Fiscal consolidation pressures (FRBM).
- Rising committed expenditure (salaries, pensions, interest payments).
- Demands for welfare schemes.
- Infrastructure financing needs.
- Challenges in rationalizing subsidies.
- Impact of global shocks.
Original Mains Question 1
"While public debt is a crucial instrument for economic development, its escalating levels pose significant macroeconomic risks, especially for emerging economies like India." Critically analyze this statement in light of India's recent debt trends and debt management strategies. What measures should India adopt to ensure long-term debt sustainability?
Key Points/Structure for Answering:
- Introduction: Acknowledge the dual role of public debt.
- Public Debt as a Tool for Development: How it finances infrastructure, social sector, counter-cyclical policies. Indian examples.
- Risks of Escalating Debt: Crowding out, inflation, interest burden, impact on credit rating, inter-generational equity, debt trap, external vulnerabilities.
- India's Recent Debt Trends: Rise post-COVID, current debt-to-GDP, composition, maturity profile. Link to FRBM targets.
- India's Debt Management Strategies: Role of MoF & RBI, FRBM framework, efforts to elongate maturity, develop G-Sec market, Sovereign Green Bonds, RBI Retail Direct. Evaluate effectiveness.
- Measures for Long-term Sustainability: Fiscal consolidation roadmap, improving quality of expenditure (more capex), revenue augmentation, establishing a Fiscal Council, prudent management of contingent liabilities, continued development of financial markets.
- Conclusion: Balanced view, emphasizing prudent fiscal management to harness benefits while mitigating risks. Implications of global bond index inclusion.