Public debt and fiscal consolidation

The first principle

A government that spends more than it collects borrows the difference, and what matters is not the size of the debt in rupees but its size against the income that services it, which is gross domestic product (GDP). Debt is safe if the economy grows faster than the interest on it and the government does not run large deficits before interest; it becomes dangerous when interest eats the budget and lenders start to doubt repayment. Fiscal consolidation is the slow work of keeping that ratio on a falling path without starving growth.

The core

Measures of debt

• Public debt and total liabilities. Public debt in the narrow sense is borrowing on the security of the Consolidated Fund of India: dated securities, treasury bills and external loans. Adding liabilities in the Public Account, such as small savings, provident funds and reserve funds, gives the Union's total liabilities, which is the measure the fiscal rules use.
• Internal and external debt. Almost all of India's government debt is in rupees and held at home, by banks, insurers, provident funds and the Reserve Bank of India (RBI). This shields India from the currency crises that hit dollar debtors.
• General government debt. Union and State debt added together, after netting the loans one level owes the other, is general government debt, the measure used to compare countries.
• Contingent and off budget liabilities. Guarantees given to public companies become debt if those companies fail, and borrowing by a public agency that is repaid from the budget is debt in all but name. Both sit outside the headline number, which is why they matter.

How the debt ratio moves

• The derivation. Let D be debt, Y nominal GDP, r the effective nominal interest rate on debt and g the nominal growth rate of GDP. Next year's debt is this year's debt plus interest plus the primary deficit P, that is D(1 + r) + P. Dividing by next year's GDP, Y(1 + g), gives the next debt ratio as d(1 + r)/(1 + g) + p, where d = D/Y and p is the primary deficit as a share of next year's GDP. Subtracting d from both sides gives the change in the ratio as (r − g) × d/(1 + g) + p.
• What the equation says. When growth exceeds the interest rate, the first term is negative, so the ratio can fall even while the government runs a modest primary deficit. When interest exceeds growth, the ratio rises unless the government runs a primary surplus. Both r and g must be nominal, or both real; mixing them is a common error.
• A worked example. Take debt at 56 per cent of GDP, an effective interest rate of 7.2 per cent, nominal growth of 10 per cent and a primary deficit of 0.7 per cent. The first term is (0.072 − 0.10) × 56/1.10 = −1.43, and adding 0.7 gives a fall of 0.73 point, to about 55.3 per cent. If growth slows to 7 per cent, the first term becomes +0.10 and the ratio rises to about 56.8 per cent. At 10 per cent growth, the debt stabilising primary deficit is 1.43 per cent of GDP; anything smaller makes the ratio fall.

The fiscal rules

• The Fiscal Responsibility and Budget Management (FRBM) Act 2003 required the Union to bring the fiscal deficit to 3 per cent of GDP and to eliminate the revenue deficit, targets that were repeatedly deferred, notably after the global financial crisis of 2008.
• The 2018 amendment, following the FRBM Review Committee chaired by N K Singh (2017), made debt the anchor: Union debt of 40 per cent and general government debt of 60 per cent of GDP, a fiscal deficit of 3 per cent, and an escape clause allowing a deviation of up to 0.5 point of GDP for national security, war, national calamity, collapse of agriculture, far reaching structural reform or a sharp fall in output growth.
• The new anchor. After the pandemic the Union followed a glide path to a fiscal deficit below 4.5 per cent by 2025-26, and from 2026-27 it targets the debt ratio itself, aiming to bring Union debt to 50 per cent of GDP, plus or minus one point, by 31 March 2031.

Dimensions

• Macroeconomic. Large deficits raise interest rates and absorb savings that firms would have borrowed, which is called crowding out; in a slump, by contrast, deficit spending props up demand, which is why rules need escape clauses.
• Budgetary. Interest is the first claim on revenue, and it is budgeted at 39.7 per cent of the Union's revenue receipts in 2026-27 (Union Budget 2026-27), leaving less for capital spending, health and education.
• Monetary. Heavy government borrowing makes the RBI's job harder, because it must keep bond markets stable while fighting inflation; since 1997 the RBI no longer finances deficits automatically through ad hoc treasury bills.
• Intergenerational. Debt that funds roads and power plants leaves assets for those who will repay it, while debt that funds subsidies and salaries leaves only the bill, which is why the quality of the deficit matters as much as its size.
• External. Rating agencies and foreign investors watch the debt ratio, so a credible path lowers borrowing costs for the whole economy.

In practice

• The numbers. The Union's fiscal deficit rose to 9.2 per cent of GDP in 2020-21 and has since fallen to 4.4 per cent in the revised estimate for 2025-26, with 4.3 per cent budgeted for 2026-27. Union debt is estimated at 56.1 per cent of GDP in 2025-26 and 55.6 per cent in 2026-27, and the primary deficit at 0.7 per cent in 2026-27 (Union Budget 2026-27).
• Borrowing. Gross market borrowing through dated securities is budgeted at Rs 17.2 lakh crore in 2026-27 and net market borrowing at Rs 11.7 lakh crore (Budget speech 2026-27).
• Quality of spending. Capital expenditure is budgeted at Rs 12.22 lakh crore, about 3.1 per cent of GDP, and effective capital expenditure, which adds grants to States for creating assets, at 4.4 per cent of GDP in 2026-27, so most new borrowing finances assets rather than consumption.
• Subsidies. Budgeted subsidies for 2026-27 are Rs 2.28 lakh crore for food, Rs 1.71 lakh crore for fertilisers and about Rs 12,100 crore for petroleum (Union Budget 2026-27). Free foodgrains and urea at a fixed price make these the hardest to cut; the farm subsidy note covers their design.
• Off budget borrowing. For several years the Food Corporation of India borrowed from the National Small Savings Fund to cover unpaid food subsidy, which kept the deficit low on paper. The Budget of 2021-22 brought food subsidy fully onto the budget, and the Union now publishes a statement of extra budgetary resources. For States, the Union counts borrowing by State companies serviced from the budget against the borrowing ceiling, and the Sixteenth Finance Commission recommended capping each State's fiscal deficit at 3 per cent of gross state domestic product, which the Union accepted in principle.

Issues and way forward

• General government debt is high. Union and State debt together remain well above the 60 per cent of GDP set in 2018, and several States have debt above 35 per cent of their output. A matching debt anchor for each State, enforced through the borrowing ceiling, would complete the framework.
• Growth carries the burden. The plan to reach 50 per cent assumes nominal growth stays well above the interest rate; if inflation and growth both fall, the same deficits push the ratio up, as the worked example shows. A primary surplus in good years is the only buffer against that risk.
• Hidden liabilities. Guarantees, power company losses and unpaid bills of States do not appear in the headline deficit. Publishing them in the budget, as the FRBM Review Committee and successive Finance Commissions have urged, would show the true position.
• No independent fiscal council. The N K Singh committee recommended a fiscal council to cost policies and check forecasts, but none has been set up.
• Subsidies that are hard to target. Open ended subsidies grow with prices and populations. Direct benefit transfer, nutrient based pricing extended to urea, and better identification of beneficiaries reduce cost without cutting support to those who need it.

Common confusions

• Fiscal deficit and debt. The fiscal deficit is a flow, the borrowing of one year, while debt is the stock built up by all past deficits.
• Fiscal deficit and primary deficit. The primary deficit is the fiscal deficit minus interest payments, so it shows what this year's policies add to debt, apart from the cost of the past.
• Nominal and real rates. The debt equation works with nominal interest and nominal growth together, or real with real; inflation lowers the debt ratio because it raises nominal GDP faster than old debt grows.
• Public debt and total liabilities. Public debt is borrowing in the Consolidated Fund only, while total liabilities add small savings, provident funds and other Public Account items.

For the exam

• Keyword bank: debt to GDP ratio, interest growth differential, primary deficit, debt stabilising primary balance, general government debt, FRBM Act, escape clause, debt anchor, crowding out, quality of fiscal deficit, effective capital expenditure, contingent liabilities, off budget borrowing, fiscal council, subsidy rationalisation.
• Previous year questions: Practise the previous year questions on this topic →
• Use in an answer:
  • Introduction with data: The Union's fiscal deficit fell from 9.2 per cent of GDP in 2020-21 to 4.4 per cent in 2025-26, and from 2026-27 the target shifts to debt itself, at 50 per cent of GDP by March 2031.
  • Introduction with a report: The FRBM Review Committee of 2017 argued that debt, not the yearly deficit, should anchor fiscal policy, a view the 2018 amendment and the new target for 2031 have adopted.
  • Conclusion: Debt stays sustainable when growth outruns interest and the primary deficit stays small, so fiscal consolidation should protect capital spending while trimming untargeted subsidies.
  • Conclusion: A debt anchor for States, an independent fiscal council and full disclosure of off budget liabilities would turn India's fiscal rules from targets into a credible framework.