The Indian economy and its debt burden

Tue, 25 Feb Pre-Open

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The interim budget known as the vote on account has been passed in parliament. The provisions of this budget are effective only for a few months until the full budget is presented by the new government. As such, it will not have much of an impact on the economy. However, it is important to understand the nuances of any budget, especially if one is a student in a B-school.

As per an article in the Financial Express, management students should be trained to analytically understand the budget. This would certainly help them later in their jobs. However, understanding the budget is not a simple task. Additionally, understanding the impact that it will have on our daily lives is even more challenging. It's not only important to understand the big picture but also the finer details. A typical example is of 'crowding-out' and 'crowding-in'. Crowding-out refers to the government borrowing money via the bond market, to fund its fiscal deficit. This sucks out funds from the economy and reduces the amount of savings that can be used for private investment. This in turn leads to higher interest rates. Crowding-in refers to the money spent by the government on various welfare schemes which puts money in people's hands. This has an effect of increasing consumption. As both these effects happen simultaneously, it can be difficult to predict the end result.

However, there is one thing that we can be sure of. If an economy relies too much on debt to fund its growth, it risks falling into a debt trap. In a debt trap, the revenue deficit spirals out of control. The revenue deficit is the difference between the government's revenues and expenses. In a debt trap, the actual difference is higher than the projected difference. This has to be made up by short term borrowing. For FY 14-15, the interest expenses of this debt burden is expected to be higher than the entire revenue deficit itself. This means that the next government would have to borrow money just to pay the interest on the existing debt.

Does this mean that India is already in a debt trap? This need not be the case if the next government could quickly bring down the quantum of the debt burden. This can be achieved with disinvestment/privatization of government PSUs as well as a significant reduction in subsidies. If the government's fiscal management could be taught in B-schools, it would certainly raise the awareness of students about this important issue. It would lead to closer scrutiny of the budget by academia. However, we doubt if this is likely to change the behavior of the government itself.