The Telegraph
Since 1st March, 1999
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- Who pays for public debt'

The author teaches at the University of Warwick, United Kingdom

Jaswant Singh earned compliments from virtually all quarters for his maiden effort in framing the country’s budget. While the budget for the next financial year was devoid of any major innovations, it at least had the virtue of being free of any obvious efforts to buy off different vote-banks. Indeed, he also seemed to take a small but courageous step forward in curing one of the major cancers affecting the exchequer. This was the proposal to raise the prices of various fertilizers so as to cut back the huge subsidy of Rs 12,700 crore on this item.

Although the finance minister had proposed only a small increase in prices, his proposal immediately attracted the ire of all politicians, including many from his own party. Ultimately, the opposition proved too much for him, and he had to announce recently that the proposal to raise fertilizer prices was withdrawn. This will mean a revenue loss of Rs 700 crore during the course of the next year. Of course, this represents a negligible amount against the background of an overall projected fiscal deficit of Rs 1,53,000 crore next year. But, the opposition to the proposed price hike and Singh’s capitulation both have a very high symbolic significance.

It is clear that the critics of the price-hike were swayed by short-term political compulsions, and not by the supposed plight of poor farmers — an increase in fertilizer prices would have an effect more on the inefficient producers than on farmers. On the other hand, the various subsidies, including that on fertilizers, have made a mockery of any attempt to practise fiscal prudence. In fact, the size of the fiscal deficit has become a non-issue. Virtually no one raised an eyebrow at the fact that the projected fiscal deficit for the next year remains a very high 5.6 per cent of the gross domestic product. Add the deficits of the various state governments, and one gets a truly shocking picture of the fiscal health of the public sector in India.

It was not always like this. In the early years of the Narasimha Rao government, fiscal discipline was one of the key targets of the government, and Manmohan Singh did manage to bring down the fiscal deficit slightly. But, after the first couple of years, Manmohan Singh, the politician, took over from his alter ego, the economist. The attempt to practise fiscal prudence was abandoned, and government expenditures continued to increase significantly faster than government revenues. In fact, the fiscal deficits would have been even higher but for the fact that the government cut back on capital expenditure.

In contrast to the current scenario, there was a lot of public debate about issues such as the appropriate size of the fiscal deficit in the mid-Nineties. In fact, the size of the projected fiscal deficit was one of the key parameters discussed every year immediately after the budget was announced by the finance minister. Perhaps, one reason why public perceptions have changed is that most of those who wanted reductions in the size of the fiscal deficit felt that a sharp increase in the rate of inflation would be an inevitable consequence of the growing deficit. However, the fact of the matter is that the control of inflation has been one of the major success stories of Indian governments in the last decade — annual price rises have been within reasonable limits in almost every year, despite the deficits remaining very high.

Does this really mean that we should stop worrying about the size of the deficit' Is the Indian economy really “deficit-proof”' It would be an extremely blinkered view if we let the government’s success in curbing inflation induce us to forget the other deleterious long-term effects of burgeoning deficits.

Unlike households who cannot continue to run deficits year after year, a government can do so, because it has other options at its control. For instance, it can finance a deficit by resorting to the printing press and simply increasing the supply of currency in the economy. Fortunately, very few governments resort to such extreme measures. The typical way in which governments finance a deficit is by borrowing from the public.

This results in “public debt”. Some people question whether public debt is any debt at all. After all, as long as the government does not resort to borrowing from abroad, the entire public debt is held within the country. In other words, domestic public are both the lenders as well as borrowers since the “government” represents the people. “Can we owe ourselves any money'” is the almost philosophical query.

But, like all debts, public debts too have to be serviced. Since interest payments are a statutory obligation, the government is committed to making these payments. Unfortunately, the sheer size of public debt implies that interest payments account for a huge fraction of the government’s revenue. This inevitably means that the government has very little revenue left over for development expenditure — it is no coincidence that the growth of capital expenditure lags far behind that of revenue expenditure. Obviously, this has an adverse effect on long-term growth prospects in the economy.

There is also a sense in which government borrowing is at the expense of private borrowing and investment. After all, there is a total supply of savings in the economy. The more the government borrows, the less is available for private investors. Hence, public borrowing “crowds out” private borrowing in the economist’s jargon. This crowding out both increases the rate of interest at which the private sector can access loanable funds and also places a quantitative restriction on the amount that they can borrow. Thus, this has an adverse effect on private investment and hence growth.

Finally, there is an important inter-generational issue at stake. If the current government borrows and invests wisely in productive assets, then increases in the absolute size of public debt does not impose any burden on future generations. The debt-service burden goes up, but so do future incomes. It is just as if a father takes a long-term loan from a bank, sets up a successful business, and then the child is required to pay off the loan from the income generated by the business. But a problem arises if current borrowings are “blown up” or spent in unproductive ways. To the extent that future incomes are correspondingly lower, debt-servicing then becomes a real burden on future generations. The sins of the father are then borne by the child. Unfortunately, we are guilty of this crime.

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