Debt Management: A Survey of Theoretical Developments and Innovations in European Practices

An overview of the Indian economy reveals that notwithstanding robust growth prospects, benign inflationary outlook and strong and resilient external sector, the fiscal situation characterised by large budget deficit and debt continues to be a matter of concern. Therefore, the major challenge is to bring about required fiscal consolidation through institution of fiscal rules. Against this backdrop, an attempt is made in this paper to assess fiscal sustainability in the context of fiscal rules. Sustainability of public debt is essentially about good house keeping by the Government. The important precondition for sustainability of fiscal policy is that Governments should have their revenues cover expenditures and where they do not, returns from investment should cover amortisation costs. Following this principle, the paper makes an attempt to assess the sustainability condition in terms of four different approaches: (a) Domar condition, (b) sustainability indicators, (c) present value budget constraint, and (d) model based approach. The empirical analysis reveals that the movements in the average interest rates vis-a-vis nominal GDP growth in recent years reflect that the rates on market related borrowings have come down and are lower than the nominal GDP growth rate, thus confirming to the weak sustainability condition. Furthermore, while the domestic debt position has shown sharp deterioration, the external debt has witnessed spectacular improvements over the years. The results of the unit root tests indicate that the null hypothesis of a unit root could not be rejected at 1% level of significance. However, at 5% level of significance the PDVDEBT series becomes stationary and thus satisfies the weak sustainability condition. Under the model based approach, the baseline scenario reveals that the revenue deficit and the fiscal deficit, though gradually decline from the levels of 2002-03, but remain at a high level 6.6 per cent and 10.4 per cent, respectively, by the end of fiscal 2009-10. Reflecting this, the level of debt relative to GDP increases from around 81 per cent in 2002-03 to 90 per cent in 2009-10. The primary deficit though declines but still remains high at 2.8%. However, there is no evidence of spillover of fiscal deficit to external sector as the trade gap is maintained at 3 to 3.5% during the period 2002-03 to 2009-10. Similarly, the benign inflationary condition also continues during the period with inflation rate measured in terms of WPI is stabilized at 4.3%. Even though fiscal deficit predominates, there is an evidence of the softening of interest rate as it declines from 9 per cent in 2002-03 to 8 per cent in 2009-10. The decline in private investment and consumption during the baseline period indicates some evidence of crowding-out. The paper, therefore, suggest further fiscal consolidation to eliminate revenue deficit by fiscal 2009-10. Thus the fiscal adjustment programme should focus on reduction in non-interest revenue expenditure and enhancement of revenues, particularly indirect tax revenue. This would be possible due to extended coverage in respect of service tax, improved collections under customs and excise duties and better compliance. In addition, emphasis should be given fixing appropriate user charges. The substantial reduction in revenue deficit would be helpful for providing higher capital outlays, which would go up from around 3% to 5% during the period. The GFD would decline to 6 per cent and the debt-GDP ratio would reach 86%. The paper, therefore, concludes that since the level of primary surplus relative to GDP is conditional on the performance of the economy in respect of economic growth, inflation and interest rate, it is expected that the strong macroeconomic fundamentals along with the enforcement of fiscal rule would ensure fiscal sustainability in the foreseeable future.