India's debt is Rising: Analysis of the new debt level and its impact

12 Oct 2020  Read 369 Views

Everyone has heard that "When life gives you a lemon, make lemonade out of it". But, nobody talks about the situation of how if a lemon drop gets in the eye, how much trouble it can be. 

This is what has happened with India. When in the 2000s, there was a sparkle in the sky, and the economy was booming, India saw an investment boom. 

This was fueled by state banks dishing out a load of loans for big infrastructure projects; however, some companies taking advantage of this boom, couldn't keep up and defaulted. Hence, banks generated Non-Performing Assets (NPAs) and struggled to give further advances.

To keep business moving, shadow banks stepped up. These financial institutions didn't follow traditional banking rules and made up an estimated 1/3rd of all new loans. 

Eventually, in 2018, shadow banking giant IL&FS defaulted on debt repayments. Its collapse sent shockwaves through the economy and shook up more traditional banks that supported the sector. This had a ripple effect, and everything went south onwards.

Currently, the icing on the cake is COVID 19, the pandemic that shook the world economy and destroyed the integration among. COVID has compelled global government agencies to spend and stimulate liquidity to spur demand in the economy. 

How has India help up in the past?

India has been the fastest-growing economy. It has been touted as an economic and geopolitical counterweight to China, but in FY2020, its growth fell to its lowest in six years; investments have weakened, and unemployment has risen. 

Between 2006-2016, rising incomes lifted 271mn people out of poverty, i.e. people below the poverty line reduced from 55% to 28%. All development policies, including Swachh Bharat, were supported by a booming economy, but during FY2019 Q3, that expansion had contracted.

India's economic output grew by a mere 4.5%, which was at its weakest pace. Many economists have said that India's growth problems are "self-inflicted". Due to the ripple effect of the fall of the NBFCs, it became difficult for people to buy luxury items such as cars. 

This hurt the automotive industry, which is one of the biggest in India. In 2019, the Automotive sector suffered the worst, and more than 1,00,000 people lost employment. Agriculture and construction were also hurt.

What is the position of India's debt?

In 2019, India stood at 8th position with 69.2% debt-to-GDP globally. The US was at first with $23 trillion debt, i.e. 104.3%. 

Debt-to-GDP is an important measure to analyze how much a country owes debt concerning its GDP. 

Let us understand this through one of the best examples; In the data released by IMF in October 2019, India had a debt of $1851 Bn and Pakistan had a debt of $226 Bn. Now, you may think that this is because either Pakistan is lucky or its authorities are efficient. 

What we forget to analyze is that Pakistan's GDP is way lower than that of India's. When we compare the debt to their respective GDP's, we will find that India's Debt-to-GDP was 68.1 while Pakistan's was 71.7%. See the difference?

 

Why does debt occur in India?

Why does a country need debt? The country's Central bank can simply print the money, right? Well, no, it's not that simple. 

You see, for example, a country spends Rs.1000 on infrastructure but generates only Rs. 800 and needs to finance the country with Rs.1200, so the country would have to borrow. Now, how does a country's government borrow? 

There are two types of debt:

External debt - borrowing from IMF, world banks, and international banks;
Internal debt - borrowed from banks, the public in the form of securities.

A country's total debt expands with the need for expansion through new infrastructure. When a nation borrows and uses the funds in building infrastructure, it improves its capacity to grow at a faster rate. 

Without relevant context, these debt-to-GDP figures can be overwhelming. The US has a Debt-to-GDP above 100%, whereas Japan had already crossed 200% in 2019.

The boom and bust

Have you seen the movie "The Big Short"? It explains how the booming housing sector in the US economy, led to more construction and buying, and eventually, defaults occurred and the bubble burst. This gave rise to a huge amount of debts and a fall in stock markets. 

This was the situation: In the beginning, the economy booms, people take loans, people have more money, so they buy more to improve the standard of living. There comes the point where debt surpasses the income, and now the people can't pay it off. This results in the burst of the bubble.

Small repetitive rise and falls of debt

long term debt cycle

The short-term debt cycles are made of boom and bursts, but the short-term debts are scaled on a long-term debt line. These long-term debt cycles come once in every 80-100 years. 

Impact of COVID-19 on India's debt

The Indian economy wasn't in great shape before COVID-19, so it has only been worse after. The report by the RBI expert committee on a resolution framework, notes that the pandemic has affected the best of companies and businesses that otherwise were viable before. 

Experts believe that banks may be more risk-averse to restructuring loans this time around, having already suffered big losses in previous restructuring efforts.

Around 19 Sectors that were not under stress before the pandemic have been hit and account for Rs. 15.5 lakh crore of debts. Retail and wholesale are worst affected with an outstanding debt of Rs. 5.4 lakh crore. The 11 sectors which were already under stress have been affected widely. NBFCs have Rs 7.98 lakh crore worth of debt.

Position of India's debt

General government debt stood at 66.4% of GDP in FY2000, and since then, it has been rising. According to a report by Motilal Oswal Financial Services, the Debt-to-GDP ratio stood at 75% in FY2020 and is most likely to accelerate. 

Government debt is a combination of liabilities of centres and states. Now, the debt ratio is likely to hit a record of 91% in FY21 according to the report. This will be the highest recorded debt since the 1980s. 

The report also predicts that it is unlikely to fall to 60% by FY40 without further hurting growth.

Why is government debt increasing?

Government debt increases as a result of government spending. Now, there are dented revenues and fiscal deficits, and debt is rising. Additional expenditures to tackle COVID-19 as well as the reduction of economic activities, mainly manufacturing, is basically what is pushing the debt-to-GDP even further. 

Also, a larger economy generally means the country's capital markets will grow, and the government can tap them to issue more debt. This means that a country's ability to pay off its obligations and the effect that debt might have on the country's economy is dependent on how large the debt is as a proportion of the overall economy.

In 2019, the Indian economy struggled to pick up the steam, and the government faced contracting tax revenue along with low domestic saving. The government thus proposed tissue debt in the international market to raise funds. Household borrowing has also been very high. 

Due to the pandemic, the GDP saw a decline of 23.9% in Q1 FY2020. Fiscal estimates of all economies across the globe have gone awry due to the impact of the economic contraction and COVID-19 related expenditure and stimulus. 

Debt-to-GDP can be controlled by two factors; either increasing the growth, which due to global recession is not possible; or decreasing the debt, which due to the need of the population and industries, is not possible. 

How is this increasing debts and deficits going to impact the economy? 

As previously discussed, the debt-to-GDP ratio implies how likely a country will be able to pay off the obligations. The higher the ratio, the less likely it is that the country can pay off its debts, and hence the default risk is higher. Global investors and credit rating agencies often see this ratio to evaluate the government's ability to fund its debt.

According to a world bank report; if the Debt-to-GDP ratio exceeds 77% for a prolonged period, it will slow down economic growth. The anticipated surge in the ratio will restrict its spending.

A MOFSL study cites that if primary spending growth eases to 7.3% in the next decade from the past decade's 11.3%, it becomes apparent that the government will be unable to grow and attract investments. This could impact the non-interest revenues spending, such as defence salary pensions, etc.

Government capital outlays have been playing a bigger role in economic growth for many years and thus, if that gets impacted, so will the GDP growth.

Conclusion

Public debt in India occurs when a country has to cover the budget deficit, to fight financial depression, to finance public expenditure, to carry out welfare programs, and to create infrastructure. 

India is in a difficult position and has no way to go forward unless better monetary and fiscal reforms are introduced. It can neither reduce the debt nor expand the growth. India will not be able to bring its debt-to-GDP percentage below 60% even by FY40, without hurting the growth. 

The only way for India to get out of this situation is to accelerate rapid growth in the economy by boosting demand. Foreign debt servicing capacity may be strengthened by export promotion and also by import substitution. The government must take some steps to strengthen exports. 

In this tense situation of standing at the brink of a major financial crisis, there is a crucial need for India to link growth with development and fill the gap between macroeconomic performance and social sector development.

About the Author: Ishita Jha | 8 Post(s)

Ishita Jha is an MBA Finance student of BIMTECH, now a blogger; trying to survive the pandemic recruitments. She can be found researching, exercising, and binging to balance life. She finds her happy place in writing.

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