Is India’s Federal Debt Sustainable? - Revisiting an Old Debate

That India faces a ‘fiscal crisis’ has been a recurrent refrain of the literature on India’s economic reforms. Indeed a central objective of the reforms process, one that has proved elusive so far, is the reduction in the fiscal deficit of the central government. The supposed intractability of the fiscal problem has provided the motivation for the passage of the Fiscal Responsibility and Budget Management Act in 2003 that commits the government to targets for the fiscal and revenue deficits. We revisit the proposition that India’s debt problem is unsustainable in light of the recently changed outlook for growth and interest rates. Using a decomposition model, we separate out the effects on the fiscal deficit of growth and government behaviour in the past. We find that if recent government behaviour were to continue, the Indian economy would to achieve a growth rate of 6.5 per cent in the coming years, something that seems eminently achievable. Next, positing a nominal growth rate of 11 per cent (or a real growth rate of 6.1 per cent) in the coming years and making suitable assumptions about revenue buoyancy and other receipts, we empirically estimate the growth in primary expenditure that would be permissible. We find that no deceleration in primary expenditure is required if we assume a revenue buoyancy of 1 or above. We compare our optimistic projections with the sombre estimates of the Kelkar Task Force and find that our estimates differ from KTF’s because the KTF report postulates much higher levels of debt than we do. Clearly, we need a consensus on what India’s debt position today is. Nevertheless, our analysis does suggest that assessments of the sustainability of India’s debt have not adequately factored in the changed outlook for growth and interest rates.