Government Debt in India: Sustainability and Risks (UPSC Economy)

Government debt is the stock of outstanding liabilities of the Union and state governments. It is the cumulative consequence of annual fiscal deficits and a measure of the taxpayer's commitment to future repayment. India's general government debt has hovered above 80 per cent of GDP since the pandemic, with the IMF warning in 2024 that the ratio could breach 100 per cent in an adverse scenario. Understanding composition, sustainability and the trade-offs of sovereign borrowing is central to any UPSC-level reading of Indian public finance.

Status of Government Debt

• The Central government's debt stood at around 57 per cent of GDP at the end of March 2023 and is projected to move toward 56 per cent by 2025-26 under the revised glide path.
• General government debt (Centre plus states) has stayed in the 81-85 per cent of GDP range.
• External debt of the sovereign is small (about 5 per cent of liabilities), limiting currency risk.
• States' debt is capped at 3 per cent of GSDP as a fiscal deficit under state FRBM laws, though several states have breached this.

Why Governments Borrow

Deficit spending finances public infrastructure, social programmes and counter-cyclical support during downturns. The Keynesian argument is that borrowed resources deployed for productive capital expenditure generate output and future tax revenues, sustaining a virtuous cycle. Budget 2025-26 allocates Rs 11.2 lakh crore for capital expenditure, most of which is debt-financed.

Factors Supporting Debt Sustainability

• Low currency risk: Roughly 95 per cent of Union liabilities are rupee-denominated, insulating the exchequer from exchange-rate shocks.
• Low interest risk: Most debt is at fixed rates; floating-rate debt is under 2 per cent of GDP.
• Maturing profile: The share of short-term securities has been declining, reducing rollover risk; weighted average maturity of outstanding G-secs exceeds 13 years.
• Captive investor base: Commercial banks, insurers, pension and provident funds absorb most issuance, smoothing yields.
• Interest Rate Growth Differential (IRGD): India's nominal GDP growth has exceeded the average interest rate on government debt. A negative IRGD means the debt-to-GDP ratio tends to decline mechanically even at moderate primary deficits.

Why Debt Still Needs to be Managed

• Statutory obligation: The FRBM Act's revised target seeks general government debt below 60 per cent of GDP (40 per cent Centre, 20 per cent states).
• Interest burden: Interest payments consumed around 24 per cent of the Centre's revenue expenditure in 2024-25, crowding out health, education and capex.
• Intergenerational inequity: Revenue-deficit borrowing shifts the tax burden to future generations without creating offsetting assets.
• Cost of borrowing: Rating downgrades (India remains BBB- with Moody's Baa3) would raise the risk premium on new issuance.
• Crowding out: Excess sovereign borrowing lifts the benchmark yield curve, raising the cost of private capex.
• Investor flight: High debt ratios can trigger FPI outflows and rupee depreciation.
• Inflation risk: Monetisation of the deficit by the RBI, once available under ways-and-means advances, can fuel inflation.
• Fiscal repression: Statutory Liquidity Ratio requirements force banks to hold G-secs at below-market yields.

The Debt-Growth Nexus

The IRGD framework shows that when nominal GDP growth exceeds the cost of borrowing, debt-to-GDP can fall even with modest deficits. India enjoys this favourable arithmetic in most years. But the calculus reverses quickly in recessions, as the pandemic year demonstrated when the debt ratio jumped by nearly 15 percentage points in a single fiscal.

Latest developments (2024-26)

• Revised glide path: Union Budget 2025-26 commits to a fiscal deficit of 4.4 per cent of GDP in FY26, down from 4.8 per cent in FY25. The Centre has also shifted to anchoring its medium-term fiscal framework on debt-to-GDP rather than the fiscal deficit, aiming for Central debt around 50 per cent of GDP by 2030-31.
• 16th Finance Commission: Reviewing the vertical and horizontal devolution and the debt limits for states, with its report expected by October 2025 for the 2026-31 cycle.
• Record borrowings: Gross market borrowings budgeted at around Rs 14.8 lakh crore in 2025-26, marginally lower than FY25.
• G-sec in global indices: Inclusion of Indian G-secs in JP Morgan's EM bond index (from June 2024) and Bloomberg's index has attracted roughly USD 20 billion of passive inflows, lowering yields and widening the investor base beyond domestic banks.
• State debt stress: Punjab, Kerala, West Bengal and Bihar remain above the 35 per cent debt-to-GSDP threshold, intensifying Centre-state friction over borrowing ceilings.
• PLI and capex: Production Linked Incentive disbursals and the Rs 1.5 lakh crore interest-free 50-year loan to states for capex are aimed at shifting borrowing from revenue to capital use, improving debt quality.

The Way Forward

Reform levers widely debated in policy circles include a full Public Debt Management Agency to consolidate debt management, an independent Fiscal Council to score the Budget's assumptions, transparent accounting of off-budget liabilities, and a medium-term debt strategy aligned with 16th FC recommendations.

UPSC Relevance

Government debt is a recurring GS III theme intersecting with budgeting, fiscal policy, monetary-fiscal coordination and Centre-state relations. Mains prompts frequently ask about debt sustainability, the FRBM framework, off-budget financing and the Keynesian defence of deficit spending. Prelims can test the IRGD concept, Article 292 and 293, the composition of public debt, and Finance Commission terms of reference. Candidates should internalise the glide path numbers, the 16th FC's likely recommendations, and IMF-World Bank debt-sustainability benchmarks to write crisp, data-anchored answers.