What matters is debt service to GDP ratio, and its sustainability

In this Mint piece, the authors rightly say that the Central debt to GDP ratio (and to an even greater level the overall debt to GDP ratio) rose under the NDA and fell under the UPA. While the 2012 numbers (numbers towards the right end in the below chart will be proven far too sanguine within a few days), the underlying point is indeed true. How is this so? Has not the UPA been fiscally irresponsible. Indeed, it has been. Let us crack this mystery.

Where is the money coming from under the UPA for the falling debt to GDP ratio? If you tax your citizens almost twice what you officially say you do (govt's official tax ratio is a bit above 10 percent of GDP, but inflation – a very real tax – is also almost at 10 percent) then yes the debt will come down proportionately. During NDA's time both growth and inflation were lower – therefore, nominal growth of GDP was much lower (and the citizens were effectively taxed lower too). Now, both the numbers have been higher.

Hence nominal growth rate fo 15 percent has been the norm in the last few years. If economy goes from 100 to 115-116, and debt from 70 to 78-79 as has been happening (including state/oil deficits etc), then yes your debt to GDP ratio will come down by about two percentage points every year. Nothing to pat the government for. They are just taxing – excuse me, inflating away – our wealth. In other words, if your (nominal, not real) income rises faster than your overall (nominal, not real) debt such that your debt to income ratio actually falls – that is not exactly fiscal doomsday.

Yes, but if Sharma and Mehra want to be even more accurate – what matters is not debt to income ratio, but debt service to income ratio, and its sustainability. That is, what percentage of your annual income goes away in interest payments. If interest rates fall in a sustainable manner (as opposed to "temporarily" being driven to fall such by central banks) by enough of a margin, that a higher debt to income ratio means a lower debt service to income ratio, such a state of affairs is indeed welcome.

While the debt to GDP ratio was around 3/4ths say during NDA times, now its around 2/3rd. But by 2003-04 ,the 10 year bond rate was 5 percent, slightly more than half than of today (graph below). Moreover, the yield curve is right now inverted (that is the short term yields are even higher than the long-term ones, around 9 and 9 percent respectively – and a big chunk of India's debt will roll over before the next 10 years)

Therefore, interest payments as a fraction of the economy was lower then. And, this without significant quantitative easing (which the West is doing, and now the RBI through OMOs or Open Market Operations at  a smaller level – and any printing-induced lower rates cannot be sustainable for long, especially if the name of your country does not being with U and ends with A – and even then as they say "nothing lasts for ever")

To conclude, whatever you spend you will take it out of the populace through taxes, borrowing, inflation, regulatory fiat etc. What matters is what you do with the expenditure. Here the article is even more disappointing. The best way remains long-gestation infra spending in India's case (as opposed to say China, where enough of this has already taken place). The bond markets in India, despite not being very developed, have their own mind and are forward-looking. They reduced the long-term yields under NDA then while have increased it under UPA as is very clear from below. Hence, to repeat, as a proportion of the economy the NDA was paying lesser in interest payments than the UPA.

The NDA also managed to "charge" us less of an inflation tax (though not by much), and taking tough reforms (privatization) and infra-spending without having a 1991 or 2008 moment (although to be fair to the UPA, the nuclear tests and Kargil war in 98/99 did pressure the NDA somewhat to reform). The UPA just benefited from these reforms and infra investments, and a global liquidity boom in the middle of the last decade. To imply, and I am not saying the authors of the Mint piece necessarily implied that, the UPA 1 and 2's fiscal and economic management has been better than the NDA is simply not true.

 

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