Dynamics of debt accumulation in India

This paper states that debt arises out of differences between cumulated primary deficits and excessive growth over interest rates. The author argues that this had been caused by an increase in the interest rate over the growth rate which led to an increase in the debt-GDP ratio. In response to this, it is recommended that through focussing on the primary balance, it could be possible to stabilise the debt-GDP ratio at current levels.

The main findings include:

• in 1950-51 the debt-GDP ratio was about 29 per cent of GDP at market prices and by 2001-02, the it had reached a level of 55.36 per cent of GDP, increasing by 26.5 percentage points. Nearly half of this increased occurred in the first three plans.
• for over 4 decades, the accumulation of central debt relative to GDP, has been entirely due to cumulated primary deficits relative to GDP; and combined with excessive interest growth rates significantly mitigated its impact. This trend reversed itself during the last three years when excessive interest rates contributed to the growth of debt
• a significant part of debt build up was absorbed by excessive interest growth rates that were adjusted to influence the inflation rate. Most intra-year variability within the debt-accumulation process was due to the volatility of the nominal growth rates
• sustaining excessive interest growth rates can no longer be expected with the introduction of liberalisation and the end of financially repressive regimes. Prospects are that the difference will remain in a narrow range, even if growth rates remain higher than interest rates
• in order to stabilise the debt-GDP ratio at current levels, it is imperative that fiscal reforms are directed towards attaining a balance on a primary account. Hence the need to focus on primary balances in an effort to control the growth in the debt-GDP ratio becomes critical
• the position of state governments would be even more difficult as the effective interest rate is higher in their case