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Economic Survey 2020-21: Higher GDP, lower interest rates counterbalance rising public debt

Anand Adhikari     January 29, 2021

The Economic Survey 2020-21 builds a case that higher growth leads to debt sustainability in an emerging economy like India because of higher GDP and lower interest rates. The public debt to GDP ratio, which was around 66-68 per cent for many years , is now expected to jump to 80 per cent plus in 2020-21. This kind of debt-to-GDP ratio is the highest in the last two decades.

In fact, global rating agencies Moody's and S&P have earlier estimated debt figures of 83.7 per cent and 82.7 per cent, respectively, for FY22.

There are widespread concerns in the market regarding implications of higher debt to GDP for future growth, sovereign downgrade by global rating agencies and the impact on currency. The survey, however, says that during economic crises, a well-designed expansionary fiscal policy stance can contribute to better economic outcomes. The survey has listed out three main arguments  which counter balances the concerns raised by the experts, economists and rating agencies. Take a look:

The Denominator Effect

The survey states that higher growth in economy in the last two and a half decades have resulted in lower debt to GDP in India because of an increase in the denominator GDP. In the early 90s, when economic reforms were initiated, the public debt was at its peak at 77 per cent of GDP. This, however, started falling afterwards. By mid 90s, it touched a low of 66 per cent and again rose to an all-time high of 83 per cent in 2003-04. Subsequently, the high growth (high denominator) partly resulted in fall to 66 per cent in the next decade. The ratio has remained largely range-bound at 66-68 per cent between 2011 and 2019.

Lower interest rate than GDP growth rate

The rock bottom interest rates in the economy also creates a good environment for debt sustainability if the GDP growth rate is higher than the interest rates. This is because the interest rate on debt paid by the government has been less than India's growth rate. The survey states that over the last two and a half decades, the GDP growth rates have been greater than interest rates. The interest rates have been on the lower side globally despite expansionary monetary policy in the post 2008 global financial meltdown.

No crowding out

The survey also dispels doubts of crowding out of private investment because of higher public debt. The survey states that for emerging economies such as India, an increase in public expenditure in areas that boost private sector's propensities to save and invest may enable private investment rather than crowding it out.

The survey explains that in an economy that has unemployed resources, an increase in government spending increases the aggregate demand in the economy, which may induce the private sector to increase their investment in new machinery to cater to the increased demand, and hence put the unused resources to productive uses. "This may have multiplier effects on aggregate demand, resulting in higher growth rates. In fact, if the public expenditure is directed to sectors where the fiscal multipliers are large - for instance for building infrastructure - such spending may significantly crowd in private investment as well," states the survey.

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