Commentary

Global trade has entered territory unlike anything seen in recent decades. Shifts in policy, technology, and geopolitics are creating a more fragmented and uncertain trading environment, with implications for economic growth in both developed and developing economies.

The Public Debt Conundrum Public finance plays a crucial role in shaping a nation’s economic trajectory, and in recent years, concerns about rising public debt have taken center stage in global economic discourse. As of 2024, global public debt levels are projected to exceed $100 trillion, with debt-to-GDP ratios approaching 100 percent by 2030 (IMF, 2024). India is no exception to this trend. The country’s central government debt has surged from approximately 45 percent of GDP in 2018 to nearly 57 percent in 2023, while the combined liabilities of both the central and state governments have risen from 70 percent to 82 percent in the same period (see Graphs 1 and 2). Furthermore, over the past three decades, global political discourse on fiscal issues has increasingly tilted toward higher government spending. Recent research analyzing data from 65 countries shows a global secular shift away from fiscal conservatism toward government expansion in electoral rhetoric (Cao, DablaNorris, & Di Gregorio, 2024). This growing debt burden and shifting policy attitudes raise critical questions about fiscal sustainability, government spending priorities, and economic resilience in the face of any future downturns. Research has consistently shown that a high debt burden reduces fiscal space, limits the government’s ability to respond to economic shocks, crowds out necessary growth-enhancing investments, and raises the risk of sovereign distress. (Brunnermeier et al., 2016; Brunnermeier & Reis, 2023; Mitchener & Tresbesch, 2023; Farhi & Tirole, 2018). Sustained debt buildups can also increase the likelihood of debt distress or a broader financial crisis. (Kose et al., 2021) Given these challenges, it is imperative to examine key questions surrounding India’s public debt: How costly is debt servicing, and what are its opportunity costs? Where does the government secure funds, and what are the broader implications? What strategies can ensure a sustainable reduction in public debt? Finally, does lowering public spending necessarily lead to debt reduction?
The Cost of High Public Debt: The high public debt burden in India imposes significant fiscal costs, particularly in the form of debt servicing and interest payments. In 2023, Indian Central Government allocated approximately 35 percent of its total revenue receipts to interest payments alone, reflecting the immense strain that debt repayment places on government finances (Graph 3). Moreover, interest payments and debt servicing accounted for about 28 percent of total revenue expenditure, making it the largest single expenditure category (Graph 4 and Graph 5). To put this into perspective, this share exceeded the combined allocation for defense, social services, and agriculture and allied activities, which together constituted only 24.5 percent of total revenue expenditure. This heavy debt servicing obligation restricts the government’s ability to invest in critical sectors such as infrastructure, healthcare, and education, thereby hampering long-term economic growth and social development. Beyond the direct fiscal burden, high public debt also affects India’s overall borrowing costs. Empirical evidence suggests that a 1 percentage point (pp) increase in the debt-to-GDP ratio leads to a 0.19 pp rise in long-term borrowing costs. (ICPP, Policy Brief) This higher cost of borrowing limits the government’s flexibility to undertake countercyclical policies during economic downturns, as increased debt levels make it more expensive to raise funds for stimulus measures. Additionally, persistently high borrowing costs can deter private sector investments by pushing up interest rates across the economy, leading to reduced capital formation and slower economic expansion.What is equally alarming is the growing debt burden of Indian states, which further compounds the fiscal strain on the economy. Among the ten largest Indian states, many allocate over 15 percent of their revenue receipts to interest payments, with some exceeding 20 percent (Graph 6). This escalating debt servicing cost at the state level, when combined with the central government’s interest payments, diverts an enormous share of public funds away from productive investments.

Where does the money come from? What are the implications? Graph 7 Lending to Gen. Govt. (%) 2020-2021 Source: Chitgupi, Aneesha, et al., Who Lends to the Indian State? XKDR Forum Working Paper 34, August 2024. As the Indian government’s borrowings have surged significantly over the past few decades, a critical question arises: Who lends to the Indian State? Governments worldwide rely on a diverse set of lenders, ranging from central banks and regulated financial institutions to private firms, foreign investors, and individuals. The composition of these borrowing sources is crucial, as it directly impacts fiscal discipline, borrowing costs, domestic economic growth, and the government’s ability to raise funds quickly during crises. Understanding these sources helps assess the sustainability of public debt and its broader economic implications. A recent XKDR working paper by Chitgupi et al (2024). provides a detailed analysis of India’s government borrowing structure, shedding light on key lending groups. In 2020-21, scheduled commercial banks (SCBs) were the largest lenders, financing 36.2% of government debt, followed by insurance companies (26.9%) and provident/ pension funds (10.4%). These institutions, which operate under regulatory mandates to invest in government debt, collectively accounted for 73.5% of the total public debt issued (Table 3). In addition, the Reserve Bank of India (RBI) contributed another 11% to the government’s borrowings that year. Taken together, these four investor groups held 84.5% of Indian state debt securities, highlighting the dominant role of regulated institutions in public financing