India's GDP-debt ratio likely to shoot up; what could be the possible way out?

COVID-19 pandemic has exerted a lot of pressure on government finances, triggering the risk of shooting the country's debt-to-GDP ratio higher.

Economists at State Bank of India in a note on July 20 said that the country's debt-to-GDP ratio will expand to 87.6 percent at the end of the current fiscal from 72.2 percent in FY20 on the back of additional borrowing by the government in wake of the COVID-19 pandemic.

More than four percentage points of the rise in the debt-to-GDP ratio are attributable to the drop in growth, which is going to result in GDP contraction during the year, the economists said, requesting on measures to address growth rather than adopting fiscal conservatism.

As per the SBI Research report, India’s debt to GDP ratio has increased gradually from Rs 58.8 lakh crore (67.4 percent of GDP) in FY12 to Rs 146.9 lakh crore (72.2 percent of GDP) in FY20. The debt to GDP ratio increased by more than 2 percent of GDP last fiscal owing to easing of nominal GDP growth from double-digit to 7.2 percent.

Economists at SBI are of the view that the debt is still not an issue for the country as most of it is domestically owned. Besides, India's foreign exchange reserves are sufficient to meet any external debt obligations.

"Though India’s debt will increase like other countries across the globe, its level of debt still remains sustainable. There is no question on the ability of the Government of India to service its debt obligations. The current level of foreign exchange reserves is sufficient to meet any external debt obligations. On the internal debt, since most of the debt is domestically owned, the debt servicing of the same is not an issue," said the SBI report.

SBI points out that in the current situation in India both the key interest rate and GDP are expected to fall further.

India's nominal GDP growth is likely to contract and based on this, the country's interest-growth differential may turn positive also. Further, if interest rates are higher than expected, then the cost of rolling over a given debt increases, SBI highlighted.

"There have been studies which show that if the difference between the interest rate and nominal growth rate is negative then there is no level of debt which is unsustainable, i.e. the government can borrow easily," SBI said.

Madan Sabnavis, Chief Economist at CARE Ratings, however, has some concerns over the rising level of debt.

"Yes, it is a problem going ahead. Right now, the situation is unusual and the positive factor for the market is that there is plenty of liquidity which is keeping rates stable. This is because the private sector is not borrowing much given depressed conditions. But taking on higher debt will mean a higher level of debt servicing in the future. This will entail also more borrowing at the gross level which is a risk. Given that we are committed to FRBM we will have a challenge going ahead," Sabnavis said.

Growth is the only mantra that can prevent the fiscal situation for getting out of control, SBI said.

Besides, economists of SBI suggest going for direct monetisation along with RBI's OMO to meet the demand.

"We believe RBI would have to still support additional borrowings only through a combination of OMO purchase and direct monetisation of the deficit. FRBM Act clearly mentions that direct monetisation of deficit can be used by the government in certain exceptional circumstances. The current pandemic is one such," SBI said in its note.

However, Sabnavis of CARE Ratings does not find direct monetisation necessary at this juncture.

"Direct monetisation is presently not required. In case there are liquidity issues that cannot be addressed by RBI through OMO or TLTRO (to address private demand for credit), then this can be considered. But any which way it will still add to the debt of the government," Sabnavis said.

Economy activity in India has been gradually recovering in stages since the lockdown began on March 25. However, economists believe that even if pre-COVID-19 levels of activity were to be achieved from August onwards, we would still see a double-digit contraction of GDP in FY21.

There will be a 6.1 percent contraction in India's GDP in the current fiscal, foreign brokerage Nomura said on July 21.

However, there are silver linings in the rural economy which is expected to grow due to favourable monsoon and government support.

Experts sat the government’s steps to support the rural economy are welcome and well-directed. In addition, more steps should be taken to support the MSMEs directly, and a complete a six-month interest subvention for the MSMEs could be considered.

Disclaimer: The above report is compiled from information available on public platforms. Moneycontrol advises users to check with certified experts before taking any investment decisions.