High Debt-to-GDP ratio and Fiscal Deficit – UPSC GS3

Utility: Direct question can be asked. Content can be used in questions related to status of economy, Covid impact, FRBM Act, Food Subsidy etc.
Recent Rise in Fiscal Deficit & Debt-to-GDP ratio 
  • Fiscal Deficit = 9.3% of GDP from 4.6% (2020)
  • Debt-to-GDP ratio = Risen to 58.73% from 51.6%
Why Fiscal Deficit (FD) is high?
  • Shortfall in revenue collection: There has been a shortfall in revenue collection due to disruption in economic activities caused by the first wave of the pandemic.
  • Accounting FCI’s borrowing in calculation of FD: Government has made a slight change in its accounting practices. It is now including full borrowings of Food Corporation of India (FCI) in calculation of Fiscal Deficit.
Food subsidy to FCI
  • Why subsidy needed?
    • The difference between the cost of procurement of food-grains and the cost of providing them to fair price shops is what FCI demands from the government as a subsidy.
    • Subsidy Arrears: When the budget allocation for a financial year is not sufficient to clear all the dues of the food subsidies bill raised by FCI, the dues of such subsidies are carried over to the next financial year. Hence, to cover these arrears FCI used various methods like bonds, unsecured short-term loans and NSSF loans etc.
  • Earlier Situation:
    • Till last year, FCI’s massive loans (to finance distribution of subsidized ration) were sourced from the National Small Savings Fund (NSSF).
    • These borrowings were part of “extra budgetary resources”. Hence, they did not reflect in the fiscal deficit.
    • This extra-budgetary borrowing was slammed by Comptroller and Auditor General (CAG) in 2019.
  • Current Situation:
    • Now, government will make budgetary provisions for the repayment of entire FCI loans. Hence, these repayments shall be counted to calculate FD.
    • Although, in both cases ultimately the burden of repayment shall lie with the government, but this change in accounting indicates transparency.
Why Debt-to-GDP ratio is at an all-time high?
The Union government’s debt has risen from 51.6% to 58.8% of the gross domestic product in the fiscal year due to high amount of borrowing. Economic contraction forced the government to borrow a record amount to meet a revenue shortfall.
Why India’s external debt increased?
  • The COVID-19 pandemic has led to an increase in debt not only for India but for most countries around the world.
  • Most of the emerging economies have government debt that is around 40% to 50% of their GDP. Compared to that India’s debt is around 75% to 80% of our GDP
  • Advanced countries like the US and Japan may have even higher debt levels. But India should not compare itself to these economies because their repayment capacity is also much higher than India.
  • Constituents of external debt (in decreasing order): Commercial borrowings (37%), Non-Resident Deposits (25%), Government borrowings (19%)
What is the problem with a large Fiscal Deficit, a high Debt-to-GDP ratio and a high external debt?
It means the government is saddled with a higher debt burden. This has the following impact:
  • Credit rating: This influences sovereign creditworthiness ratings assigned by global rating agencies which tend to increase the government’s borrowing costs.
  • Repayment issues under unforeseen circumstances: Borrowing more money means that you’ll have to pay it back at some point in time. COVID has already led to a high fiscal uncertainty as per the 15th Finance Commission. Future unforeseen circumstances like another pandemic or a war in the near term, can lead to subdued growth, and then this debt will become a problem.
What are the targets for FD and Debt-to-GDP ratio as per FRBM Act?
The Fiscal Responsibility and Budget Management (FRBM) Act, as amended in 2008, mandated the following:
  • Fiscal Deficit target: Centre needs to limit the fiscal deficit to 3% of the country’s gross domestic product (GDP) by March 31, 2021. Note: FRBM Act includes an escape clause in situations of calamity and national security. In such situations, the government can deviate from its annual fiscal deficit target.
  • In light of COVID-induced uncertainty, government is now eyeing a Fiscal Deficit target of 6.8% in 2021-22 and a gradual reduction to 4.6% in 2025-26.
  • Debt-to-GDP ratio: Bringing down the debt-to-GDP ratio of the Centre to 40% and that of states to 20% by 2024-25.
Note: Fifteenth Finance Commission (FFC) has recommended setting up an FRBM review panel to draft a new fiscal consolidation framework because the current challenges have made the earlier targets impossible to achieve.
Is there a way out of this entire situation? /How can India tackle this problem of rising debt burden?
  • The FFC has recommended a slow and gradual decline in central government and general government debt to 56.6% and 85.7% (of GDP), respectively, by FY26.
  • Improved tax revenue via increased compliance
  • Increased receipts from monetization of assets, including public sector enterprises and land.
  • Increase in capital expenditure via private investments
  • Higher fiscal stimulus to revive businesses, increase in employment etc