Economy & Politics

Thursday June 25, 2020

Debt and Growth June 2020

Speaker:  Adit Jain, IMA India June 2020

Watch the Threshold

An important component of your engagement with IMA comprises the understanding of strategic risks and opportunities within the market place. The sort of risks that affect longer term growth prospects of the economy and consequently, those of businesses are amongst these. This paper will explain the influence of public debt on economic growth. The reason this is now relevant is that the response to the lockdown and subsequent economic ruin, has been through a combination of monetary policy tweaks by the Reserve Bank of India and fiscal incentives by the Government. This response will lead to a spurt in public debt, which has implications on the sustainability of economic growth.

Public debt, quite simply, is government borrowings. Currently this stands at about 70% of GDP, but economists estimate the figure will jump to 85% over the year and, as I explained in my recent paper Ratings Downgrade, increase further or at best stabilise thereafter. On this score, India’s debt burden is about 30% higher than comparable countries in a similar stage of development. Structurally less productive economies force governments to borrow more, as more funds are required to achieve a targeted level of economic output as compared to more productive economies. Basically, for countries as in businesses, growth is a combination of investment and productivity. When fiscal irresponsibility becomes acute and governments borrow to spend, they crowd out private capital, which is usually more productive. In India, there are various reasons for lower productivity, including low female participation in the workforce and the lack of structural reforms in land and labour.

The extent that public debt impacts growth varies for developed and developing nations. Advanced countries can carry higher debt obligations and, in any event, their target growth rates are usually lower than for developing economies. Whilst the equations remain empirical, economists believe that when public debt rises beyond 90% of GDP, sustainable growth levels begin to falter. The threshold levels for emerging markets are considered to be much lower and countries invite trouble by running irresponsible budgets. Higher public debt causes lower growth, just as lower growth causes higher public debt, leading to a vicious cycle that can become the basis for economic disaster. Under a compelling circumstance, such as the one we now face, the Government has few decent options to ensure growth. It has, hence, relied on a combination of spending, which in the short term may induce a boost to consumption, together with loose monetary policies that provide liquidity to keep financial markets greased. But it has also proposed some reforms, for instance, in agriculture, labour, and mining, with a hope of more to follow. Nevertheless, in the longer-term, business planners need to keep a check on the public debt figure. If this remains at levels of over 90% of GDP, growth and consumption will inevitably moderate. If, on the other hand, productivity rises through structural reforms, public debt will stabilise and perhaps even reduce as a measure of GDP.

Many industries have, over the years, used economic growth forecasts to benchmark the market for their own products. The automotive industry uses this as one key input in its planning process, together with others such as a rise or decline in household incomes, rise in bank debt, etc. Even if an industry cannot claim a direct correlation, the fact remains that growth trends provide a longer-term perspective on the attractiveness of a market. One indicator that provides a window into sustainable growth prospects is the percentage of public debt as a measure of GDP.