In the next 5 minutes, you will learn about government borrowing in India and the associated dangers. If you have always read this term in the newspaper but never understood it completely, don’t worry because I will use no jargon. Like the heading says, its in plain English.
In the last post I explained what a fiscal deficit means and specifically showed how India has fared in this respect over the last few years. If you have not read it I strongly recommend reading the article on fiscal deficit at Capital Orbit.
Individual – Deficit and Borrowing
If you and I spent more than what we earned in a year we would need to borrow the shortfall or deficit from someone. That someone could be your parents, friends or a bank. We would then be responsible for a loan. We will have to make interest and principal repayments on the loan from our earnings in future years.
Government – Deficit and Borrowing
Similarly, if the Government of India spends more than it earns in a year it has to take a loan from someone.
How? It issues Government securities which include bills and bonds. Don’t worry, these are the only new “finance” words you will see. They are exactly like loans. The public including mutual funds and insurance companies can buy these securities. Foreign institutional investors (FIIs) also can buy this government debt. In effect they lend money to the government. The government owes this money to the securities holders.
These securities have a rate of interest that is paid to the security holder. The securities are traded in debt markets. One mutual fund may buy a Government bond initially and sell it to an insurance company a few months later. Interest is paid out at fixed intervals to the bond-holder. Usually, when the the debt period is over (also called as maturity) the principal is paid back to the bond-holder thus settling the debt.
Government borrowing in India as percentage of GDP
Again, like I explained in the previous article most newspapers and magazines talk about government debt as a percentage of GDP. GDP is the market value of all final goods and services produced in a country in a year. The GDP number includes both government spending and private consumption of goods and services. The chart below is that of government debt in India as a percentage of GDP over the last 6 years.
Government borrowing in India as percentage of total government receipts
Similarly, like we have seen earlier, it is very useful to study the government only as a standalone entity.
Why? Because the government eventually has to pay back the debt with its own earnings.
The chart below shows India’s government debt as a percentage of the total receipts of the Government for the last 6 years respectively.
Source: Planning Commission
What does it mean practically?
Suppose your salary was Rs. 10 lakh per annum. And you had taken a home loan of Rs. 50 lakh which is 5 times your annual salary.
At today’s interest rate of close to 10% you would be paying close to Rs. 6 lakh per annum in EMI on this loan. That leaves you with Rs. 4 lakh to spend on your needs.
It will be tough to see a bank sanction a loan like that in reality.
Well, the government does not pay 10%. They always pay the least interest in the economy. Today it is close to 8% for a 10 year bond. (Think of it like a 10 year loan to the Government of India)
Yet, the government is not in a very different position. The last bar in the chart above that shows that India’s government borrowing outstanding at the end of financial year 2012 is 5.6 times what it earned in the year.
Pretty high, huh?
What are the dangers of excess government borrowing for India?
- If you took a loan its you who will pay it back. Politicians who run the government can have too much expenditure over less revenue and raise debt to cover the gap.
- Today is taken care of. But, we and the future generations of the India’s citizens have to pay the debt back.
- The private sector also seeks to borrow for setting up new businesses. But since there is limited money in the system, they end up competing with the government for the same debt and get “crowded out“.
There is one last danger that is most insidious that I will explain in my next article.
I will leave you with a clue. It is a silent and deadly tax that steals money from the pockets of citizens without them even noticing.
The next article can be found here. Read on!