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A matter of life and debt

Presenting the second of the rediff.com-Dun & Bradstreet India special Budget Impact series. This article says that burgeoning interest payments may lead the government to a point of no return.

India's government debt (including that of the central and state governments) is estimated at 61 per cent of the GDP as on March 31, 2000. How high is this in comparison with other countries?

Most of the G-7 countries are running a high government debt. Japan's gross government debt, for instance, is estimated at 108 per cent of the GDP at the end of 1999. Italy's debt is estimated at 117 per cent. Also, both Canada and France have higher government debt as a percentage of GDP than India. The US and the UK come very close at 56 per cent and 57 per cent.

So why is India seen as heading for an internal debt trap?
It is the high cost of debt servicing which has become a serious cause for concern. For one, interest rates on the outstanding debt are substantially high by international standards, thereby imposing a heavier burden on interest payments and hence the fiscal deficit. Second, the existing maturity profile of government debt is skewed towards the shorter end, resulting in huge redemption pressures year after year.

In 1999-2000, interest payments on existing debt of central government are estimated at Rs 914.25 billion which are higher than the net borrowings budgeted for the year. Interest payments are budgeted to touch Rs 1,001 billion in 2000-01. Hence, gross borrowings would continue to increase proportionally due to interest and redemption pressures. If this continues for some more years, gross borrowings may become too large to be financed by the market and the government will have to opt for huge monetisation to support its borrowing programme. This could certainly prove disastrous for the Indian economy.

Can the interest payment burden be brought down?
The finance minister, realising the gravity of fiscal situation, had commented earlier (in October 1999) that the country was heading for an internal debt trap unless some strict measures were taken. The steps taken since that announcement have not been sufficient. Removal of small savings and provident fund from its internal liabilities and changing the base year in GDP calculations have only helped the government project a better picture on the fiscal deficit front though there has been no real improvement of underlying fundamentals. The 1 per cent cut in the small savings interest rate announced in January 2000 was perceived as a bold step which would help state governments in reducing their interest burden.

The 1 per cent reduction in the rate of General Provident Fund announced in Budget 2000 is another attempt on the part of the finance minister to lower the level of interest rate in the economy which in turn will help reduce its debt service burden.

However, it must be pointed out that the finance minister's attempts to tackle the fiscal deficit through interest rate cuts on small savings and the General Provident Fund will not be sufficient.

The finance minister has given the cue for a lower interest rate regime through the above cuts in interest rates. It is now for the Reserve Bank of India to decide whether or not it wishes to cut the Bank Rate or lower the Cash Reserve Ratio requirements against the background of current macroeconomic indicators.

Need to generate surplus on primary account
The government, therefore, has to endeavour to wipe out at least the primary deficit and in turn generate a primary surplus in coming years. The primary deficit in 1999-2000 stands at Rs 174.73 billion. In 1999-00, the finance minister had budgeted a primary surplus of Rs 80.45 billion, which was not achieved. Budget 2000 does not even attempt to generate a primary surplus. In fact, the government has budgeted for a primary deficit of Rs 100.09 billion in 2000-01, which shows that the government appears to be losing the fiscal battle.

The only way the debt trap can be avoided in the coming years is by generating a substantial surplus on the primary account. Hence, the focus has to be on increasing revenues and enforcing strict discipline on the expenditure side. Budget 2000 seems to lack the necessary punch to achieve this.

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