Public debt may jump in the short term

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The Centre’s interest payments, which were nearly 48% of its net tax receipts in FY21 before moderating to 43% in FY22, will rise again this fiscal and may even cross the 50% mark in FY24. The interest costs of states may also see a similar spike, constricting capital expenditure financed out of Central and state budgets.

The impact of the rate hike cycle commenced by the Reserve Bank of India to control runaway inflation will be felt on the government’s interest costs starting H2 FY23, but it will be more pronounced in FY24.

The Budget FY23 estimated the Centre’s interest payments this year to be 48.6% of its net tax receipts due to the sharply increased size of the borrowings in FY21 (Rs 12.6 trillion) and FY22 (Rs 10.47 trillion), though the funds were raised at benign interest rates. The quantum of borrowings is projected to rise to a record Rs 14.95 trillion in FY23, which, coupled with the higher interest rates will raise the debt servicing costs to much higher levels in the short to medium term.

From a little under 70% in FY18, the ratio of general government debt to the GDP rose to a very precarious level of close to 90% in FY21 as the Covid-19 pandemic diminished revenues and raised expenditure requirements at once. An expert committee on fiscal management had recommended containing the ratio at 60% to avoid the debt spiralling out of control. There was a welcome, earlier-than-expected reversal of the trend in FY22 when the debt-to-GDP ratio fell to 85.2% mainly because revenue streams accelerated.

A further moderation of the ratio to 84.3% is forecast by the RBI and this projection may still hold good because elevated inflation will jack up nominal GDP to much a higher level than projected. But that is clearly not the ideal way of controlling the debt.

The Budget projected a nominal GDP growth of 11.1% in FY23 based on the first advance estimate by the National Statistical Office (NSO) and based on the second advance estimate, the growth required to achieve the budgeted nominal GDP is just 9.1%. The nominal GDP growth, however, could be as high as 14%, given the 7.2% real GDP growth projected by the RBI and a likley GDP deflator of 6-7%.

On the positive side, the Centre’s net tax revenues in FY23 could be Rs 1.7 trillion higher than the BE of Rs 19.35 trillion. The current revenue buoyancy, however, will be dented if the economic growth continues to sputter over the next few quarters.    

To be sure, the prolonged geopolitical tensions – which could not have been foreseen when the Centre and states prepared their budgets for FY23 – are going to seriously change many variables, tax receipts, size of the nominal GDP, and thereby impact the magnitude of government debt.

States have also seen spikes in their interest payments with many states, leading to debt sustainability issues. States aggregate interest payments rose from about Rs 2.93 trillion or 17% of their total tax receipts (own receipts plus devolution funds received from the Centre) in FY18 to about Rs 3.62 trillion or 20% of total tax receipts in FY21 and are seen to have hovered around 20% in FY22.

The RBI has projected that after moderating to 85.2% in FY22, the ratio of general government debt to GDP is likely to remain sticky at around 84% of GDP over the next five years, in the baseline scenario, but warned it could worsen to 89.1% by FY27 if economic growth stagnates at 5% from FY24 onwards. This graver estimate appear to be more realistic given the recent macroeconomic developments.

The Centre’s ballooning Budget deficit in FY21 pushed its debt-to-GDP to a 14-year high of about 59% in FY21. The aggregate debt of states reached a 15-year high of 30.1% of GDP in that year.

According to their respective budget estimates, states with the highest debt-GSDP ratio in FY22 are Punjab (53.3%), Rajasthan (39.8%), West Bengal (38.8%), Kerala (38.3%) and Andhra Pradesh (37.6%). As a consequence, Punjab’s annual debt servicing liability is almost the same as its annual gross borrowings, leaving little resources for asset creation.

“For the state governments as a whole, our baseline expectation is the gross SDL (state development loans) issuance of Rs 8.4 trillion in FY23, although the adjustment for off-budget borrowings, and the timing of central transfers may pose a downside to the same. Simultaneously, yields are expected to harden over the course of FY23, which would create an upward pressure on interest payments going ahead,” Icra chief economist Aditi Nayar said.

After the surprise rate action by the RBI on May 4, the 10-year central government securities (G-secs) yield closed at 7.38%, a three-year high. Analysts expect the benchmark yield could be in the range of 8-8.5% soon. Many states may have to raise SDLs at rates 50 bps higher than the G-secs.

“While recovery in the growth rate will bring down the debt-GDP ratio, the Centre and the states should continue to give thrust to more growth-inducing capex to bring down the combined debt level to around 80% in five years or so,” said N R Bhanumurthy, vice-chancellor of Bengaluru Dr B R Ambedkar School of Economics University. The question, of course, is if this will be feasible in the short term given the higher than estimated subsidy expenditure caused by elevated global prices of fertilisers, natural gas, chemicals and oil.