DH Deciphers | What is public debt? Why is the government borrowing more?

The government has decided to raise its borrowing to Rs 12 lakh crore for 2020-21 in order to cope with the financial difficulties caused by Covid-19. Any increase in the public debt will worsen the ratio of India’s debt-to-GDP which, according to the IMF, is already higher than the average of emerging market economies. So what exactly is public debt, how is it calculated and how does it impact the economy and the jobs?

First things first, what is public debt?

Public debt is the amount of money borrowed by the government within the country and abroad. It is also known as sovereign debt or national debt. It is often calculated as a percentage of the gross domestic product (GDP).

Why does the government borrow money? Where does all the tax money go?

Like all of us, the government, too, has many expenses. Besides paying its employees, the government needs to spend on infrastructure (such as roads, rail network, etc), education, health, internal security (police, paramilitary, etc), defence and other social services. These expenses are supposed to be paid through tax and non-tax revenues. But most often, these revenues aren't enough for the government's ever-growing expenses (the government always spends more than it earns). So the government partly pays for these expenses by borrowing money. This is called public debt. It can be internal, which is raised from within the country, or external. But over the years, India has been consciously lowering its external debt for reasons that are not far to seek. Internal debt constitutes over 90% of the total public debt.

What is the current level of public debt?

As stated above, the public debt is calculated as a percentage of the GDP, which is the total economic output in a given financial year. For example, if India produces Rs 100 worth of goods and services but owes Rs 70 to the creditors, the debt-to-GDP ratio will be 70%. While it's 72% at present, the ratio is likely to balloon to 87% by the end of this financial year due to Covid-19 and rising government expenses, according to economists. For the record, the public debt was 146.9 lakh crore, or 72.2% of the GDP, in 2019-20.

Is public debt bad for the sovereign?

No. But the government, like a typical household which takes loans when expenses are higher than the income, must have the capacity to repay the debt. Secondly, the debt must be for investment and capital formation, which could contribute to the real income of the people and add to the government’s repayment capacity. But if the debt is used to meet the day-to-day expenses of the government, it may well reach unsustainable levels. High levels of debt slow down the economy because a large portion of what a country earns through tax revenues goes into repayment of the debt and the interest rather than being employed into productive use. When the economy slows down, unemployment rises and there is a deterioration in people’s standard of living. The national debt is nothing but the debt per capita.

What is the sustainable level of public debt? What if it remains higher?

The threshold level of a desirable government debt-to-GDP ratio for India is 61%, beyond which it starts impacting the economy. India’s public debt had remained comfortable until the 1980s after which state finances started showing fiscal stress. The debt-to-GDP rose to nearly 73% in the 1990s, from 48% in the 1980s. There was some improvement in the public debt position from 1992 to 98 when the government undertook economic reforms following the balance of payments crisis. The balance of payments is the difference between all the money coming into a country and all the money going out of it during a particular period in time.

Can't the government avoid borrowing more?

Rather than explore borrowings from external sources, usually at higher interest rates, the government and the RBI may go in for direct monetisation, according to experts. This means the RBI may print more money to finance the government’s rising debt and deficits. While printing more money could increase the inflation, that may not be the case given the current contraction in the economy.