COVID-19 pandemic and the lockdowns induced by it have caused heavy destruction to the Indian economy, so much so that it has been estimated by the State Bank of India's research note "Ecowrap" that India's gross debt will surge to be 87.6% of the GDP in FY21, as compared to 72.2% in FY20.

The report stated that due to high amount of borrowings by the government and a downfall in the GDP this fiscal year, the country's debt will increase from Rs. 146.9 lakh crore (FY20) to Rs. 170 lakh crore (FY21).

This debt-to-GDP ratio has gradually increased from Rs. 58.8 lakh crore (67.4% of GDP) in FY12, to Rs. 146.9 lakh crore (72.2% of GDP) in FY20, according to the report.

The debt-to-GDP ratio essentially portrays the likeliness of a country to pay off its debt. The higher the ratio, the less likely it is to repay the debt, and hence, the higher is its risk of default. This ratio is often looked at by investors, as it helps them evaluate the government's ability to fund its debt. According to a report by the World Bank, if the debt-to-GDP ratio of a country exceeds 77% for a prolonged duration of time, it rapidly slows down its economic growth.

Bright Side

The research note indicated that there may be a silver lining to the falling yields on both central and state government bonds, which will in turn help the Centre bring down its debt servicing costs.

So far, the weighted average cut-off yield for states has reduced from 7.23% to 6.49% in FY20. The same for the Centre has come down to 4.53% in FY21 from 6.85% in FY20. This might, in turn, help in reducing interest costs significantly, according to the report.

The research note further added that out of the expected gross debt for FY21, the external debt is likely to rise to Rs. 6.8 lakh crore, which amounts to 3.5% of the GDP.

Word of Caution

The report further cautioned that this high debt amount may also result in a shift in the fiscal responsibility and budget management (FRBM) target of combined debt (i.e., both centre and states) to 60% of the GDP by FY23, by a leap of 7 years. The target will only be achievable earliest by FY30, if not later than that.

Pertaining to the current situation in India, and elaborating upon the same, the report highlighted the bigger question, which is the sustainability of debt. Given the present circumstances, our nominal GDP growth is likely to contract substantially. This will further turn positive the interest-growth differential in FY21, thus raising serious questions on debt sustainability.

However, the research cast no doubt when it comes to the government's ability to service its debt obligations. According to the report, the current level of the government's foreign exchange reserves are enough to meet any external debt commitments.

This being said, the report further noted that India's GDP decline may raise the debt-to-GDP ratio by a minimum of 4%. This implies that the only mantra to get India back on its economic track is growth, rather than a continued fiscal conservatism.