Has debt been rising too quickly?

Have we been caught off-guard and let debt slip out of control in India? Have we stretched the debt level too high?

This is difficult to ascertain as some of the increase reflects progress in developing the financial systems of economies. It has been seen that higher debt is better managed with robust financial systems to ensure that it contributes to development. These caveats suggest that it would be difficult to establish a threshold for the ratio of debt-to-GDP beyond which debt is considered too high.

The entry of companies into capital intensive sectors like infrastructure, roadways, power, ports and airports has meant that corporate debt has grown at a much faster pace. This has resulted in a sudden surge in corporate debt-to-GDP ratio.

Since 2003/04, Indian companies' outstanding debt has increased at a compound annual growth rate (CAGR) of 24.8 per cent, more than double the 11.4 per cent rate for India's public debt during the period.

While it is natural to have the Union government as the largest borrower, it is also equally critical to ensure that the deficit is dealt with in a timely manner and payment is not deferred. Common sense tells us that the ratio of debt to GDP should not be allowed to rise year after year.

While an increase in the debt ratio can in principle be reversed, it becomes harder to do so as the interest rate rises, accelerating the growth of the debt and decreasing the growth of GDP.

A continuing rise in the ratio of debt to GDP is a path to insolvency and economic crisis. Even a stable but high ratio of debt to GDP has serious adverse effects on the economy by crowding out private capital formation and imposing a higher tax burden to service the debt.

Hence, policy makers tend to be concerned about any rapid rise in debt, as excessive growth in credit has been linked with increased probability of crisis.

If the trend of rapid growth were to continue, the economy could face increased risk of a financial crisis.

What can governments do to manage credit growth? While the rapid rise of debt causes some concern to policy makers, no clear consensus exists on what should be done.

The structural reforms are expected to boost India's prospects and the initial phase of the government's effort to remove structural bottlenecks is bringing back the investor confidence.

But the government must keep an eye on debt to ensure a safer tomorrow. The debt should not catch us unawares.

(The author is Chairman, Hindustan Powerprojects)