A public debt target for India?

Petia Topalova and Dan Nyberg in a new paper write:

This paper discusses possible medium-term public debt targets for India, based on evidence from the economic literature on prudent levels of public debt and the feasibility for the country to meet a particular target over the next 5-6 years. While recognizing the challenges in determining an appropriate debt target, cross-country analysis and simulations suggest that a debt ratio in the range of 60-65 percent of GDP by 2015/16 might be suitable for India. Such a debt ceiling, while still above the average debt level for emerging markets, is within the range of debt ratios that would provide room for countercyclical fiscal policy and contingent liabilities. It would also send a strong signal of the government’s commitment to fiscal consolidation by making a clear break with the past.

Currently it is at around 78% of GDP and is high in the emerging market space. It has also made the least progress in reducing its debt despite great growth.

The authors do a scenario analysis for public debt levels:

  • The baseline scenario with no changes in current policy:  yields only moderate deficit and debt consolidation, with the overall deficit improving to 6.5 percent of GDP at the end of the simulation period in 2015/16, and the debt level declining by only 7.3 percentage points from 81.2 to 74 percent of GDP, roughly the level of public sector debt in 2000/01. Despite its declining path under the baseline scenario, public debt remains elevated and the public debt dynamic is vulnerable to various shocks as suggested by the IMF Debt Sustainability Analysis (DSA).
  • Subsidy reform is a powerful tool for consolidation as the overall general government deficit improves by 6.4 percentage points of GDP to 4.4 percent and the debt declines 15.3 percentage points to 66 percent of GDP between 2009/10 and 2015/16.
  • Further revenue  reform will also yield significant fiscal consolidation as the public debt level is brought down to 70.6 percent of GDP, a decline of 10.6 percentage points, while the general government deficit is at 5.3 percent of GDP by 2015/16.
  • Privatization proceeds can also be a significant contributor to the reduction in debt levels. Just the divestment of Rs 2,000 billion of assets alone can help bring down the debt-to-GDP ratio to 71.5 percent of GDP. However, the speed of the adjustment of public debt is the slowest after the baseline scenario.
  • Finally, the combined scenario (subsidy and revenue reform, combined with privatization) is the most powerful tool for fiscal consolidation. Under this scenario, the overall debt declines by close to 22 percentage points to 59.5 percent of GDP, while the general government deficit narrows to 3 percent of GDP. 

Based on above, the authors suggest a 60-65% debt level target for India.  

A 60-65 percent of GDP debt ceiling, while still above the average debt level for emerging markets, is within the range of debt ratios that would allow substantial countercyclical fiscal response and provide headroom for large contingent liabilities as identified in the literature. It is also a level of debt that could be sustainable given reasonable assumptions about the future interest-growth differential and primary balances.

A debt target of 60-65 percent, lower than India’s lowest debt ratio over the past 20 years, would send a strong signal of the government’s commitment to fiscal rectitude by making a clear break with the past.

Achieving this debt ceiling by 2015/16 would require substantial efforts – subsidy reform would be crucial in containing current spending, continued efforts to improve tax administration and widen the tax base are needed to raise revenues, and disinvestment of public assets could lighten the debt burden

Given the political situation, I don’t think subsidy reforms can happen. At best we can have some revenue reform and privatisation. The big issue always has been subsidy reforms. It is well known that it is a major contributor to worsening of the fiscal situation. So, am not surprised by the simulation results. Subsidy reform leads to the best performance but is the most difficult to do. 

Based on above debt levels would remain around 70% mark for sometime ahead, (provided things don’t become worse!). Rogoff and Reinhart in their paper show such debt levels may not really hamper growth but leads to higher inflation.

One Response to “A public debt target for India?”

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