- Evolution of debt
- Medium term debt
- Growth-enhancing interventions
COVID lessons for Economy
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COVID-19 had exposed the vulnerabilities of the Indian economic and social infrastructure. A debate is underway in the country about what should be the appropriate fiscal response to the damage that has been inflicted by the pandemic.
Evolution of debt:
- The evolution of debt is essentially a function of three variables: The primary deficit (fiscal deficit net of interest payments) and the relationship between nominal GDP growth and the government’s cost of borrowing.
- The higher is the difference between growth and cost of borrowing, the greater is the depreciation of the existing debt stock.
- High growth allows countries to “grow out” of their debts but high primary deficits worsen the debt burden.
- India comes into COVID-19 with a debt/GDP of about 70 per cent, a primary deficit across the Centre and states of about 2.5 percent of GDP (including the Centre’s extra-budgetary resources).
- India presently has a weighted average sovereign borrowing cost of about 7.5 per cent (on the stock of debt) and an estimated pre-COVID nominal GDP growth of 7.5 per cent in 2019-20.
- In other words, the favourable gap between growth and borrowing costs had closed.
- This indicates that even under relatively benign scenarios (nominal GDP growth of 4 per cent and a fiscal expansion of 3 percent of GDP this year) India’s debt/GDP will balloon towards 80 per cent by the end of the year.
- But India will not be alone. Public debt is expected to balloon all over the world.
- Instead, what will matter for sustainability is the trajectory of debt thereafter. Does debt/GDP come down or keep going up in subsequent years?
Medium term growth:
- The subsequent trajectory depends overwhelmingly on medium-term growth.
- Even if this year’s combined fiscal deficit widens by 6 percent of GDP as long as nominal GDP is 10 per cent in the medium term (which corresponds to real GDP growth of 7 per cent), debt/GDP gets on to a constantly declining path after the third year.
- This suggests a bigger fiscal intervention is sustainable but only if medium-term growth prospects are lifted in tandem.
- In contrast, if this year’s deficit widens by “just” 3 percent of GDP but if medium-term nominal GDP growth settles at 8 per cent (that is, real GDP growth of 5 per cent), debt/GDP rises relentlessly for the next decade towards 90 per cent of GDP.
- This suggests even a relatively-conservative fiscal response this year becomes unsustainable if medium-term growth prospects are diminished.
- Small changes in medium-term growth have large implications for fiscal sustainability.
- The medium-term sustainability of any fiscal package this year will depend on the nature of growth-enhancing interventions and reforms that accompany it.
1. Induction of working capital:
- The government’s policy must ensure that all viable enterprises can survive the pandemic.
- The government’s credit-guarantee scheme should induce banks to provide much-need working capital to keep small businesses afloat.
- The bond market interventions (special liquidity and partial guarantee funds) are important to ease conditions at the financial periphery.
- Preemptively recapitalising public sector banks for growth and resolution capital, conducting an Asset Quality Review for the NBFC sector and modifying the incentives under which public sector banks operate will be crucial to strengthening the financial sector.
- Higher potential growth is only feasible if the financial sector is able to fund it.
2. Special Export Zone model:
- As COVID-19 hastens the reorganisation of supply-chains within Asia, India must seize the moment to integrate into the Asian supply chain.
- India needs a Special Export Zone (SEZ) model to help create discrete ecosystems within the country that enable globally-competitive export production.
- If the first one or two SEZs succeed, it would create a powerful demonstration effect both externally (to help attract more firms into India) and internally (inducing different states to compete to create their own SEZs to drive jobs and investment).
3. Social infrastructure:
- It is the criticality of social infrastructure that has been exposed by the pandemic.
- India will not be able to fundamentally alter its growth potential without crucial investments in health and education.
- Existing assets on the public sector balance sheet must be aggressively monetised to fund growth-enhancing investments in physical and social infrastructure.
- This will simultaneously take the pressure off the fiscal and financial sectors, and deliver a productivity-enhancing swap on the public sector balance sheet.
Higher potential growth is the antidote to many pressures, from incomes to jobs to debt sustainability, and this opportunity for structural reforms in the country must be seized. The unprecedented crisis needs strong policy interventions, fiscal reforms and capital to restore the health of the economy.