NEW DELHI: When the government laid out its debt consolidation roadmap in the FY26 Budget, it attached an important caveat. Starting FY27, the Centre said it would aim to bring its debt down to around 50 per cent of GDP over five years, provided there were no “major macro-economic disruptive exogenous shocks”.
A year later, that assumption is already under strain.
The first year of the government’s debt reduction glide path coincided with a war in West Asia. While geopolitical tensions have somewhat eased now, the fiscal costs incurred during the episode is likely to leave a longer mark. Further ahead lie domestic developments, including the implementation of the Eighth Central Pay Commission and the Lok Sabha election in 2029, both of which could potentially add expenditure pressure.
The government’s task has become harder even before accounting for these risks. Following the introduction of the new GDP series, nominal GDP for FY26 was revised downward, pushing the Centre’s debt-to-GDP ratio to 57.8 per cent from the 56.1 per cent assumed in the debt roadmap. As a result, the planned reduction in the debt ratio has become 170 basis points steeper than originally envisaged.
The target may already be slipping out of reach, according to Pronab Sen, economist and former chief statistician of India.
“Realistically, the government may be able to reduce the debt-to-GDP ratio by only 2-2.25 percentage points over five years,” Sen said. The Centre’s debt burden may approach 50 per cent of GDP only by FY37, he added.
The government missing a debt consolidation target is not entirely an unknown phenomenon. Following the review of the FRBM Act in 2018, the amended framework by the NK Singh committee delineated a fiscal deficit aim of 3 per cent of GDP by FY23 and a debt target of 40 per cent of GDP by FY25 for the Centre.
Then came the Covid-19 pandemic.
The unprecedented economic shock forced the government to abandon those targets as it ramped up spending to support the economy. The Centre’s fiscal deficit surged to 9.2 per cent of GDP in FY21, while its debt burden climbed to 61.4 per cent of GDP.
Sitharaman later unveiled a new fiscal consolidation roadmap in the FY22 Budget, targeting a reduction in the fiscal deficit to 4.5 per cent of GDP by FY26.
The government ultimately surpassed that goal, with the fiscal deficit narrowing to 4.4 per cent of GDP in FY26. Even as deficit reduction dominated the fiscal agenda over the past five years, debt consolidation largely took a back seat. The Centre’s debt-to-GDP ratio has declined by only 3.6 percentage points since FY21.
Debt reduction returned to the centre of fiscal policymaking only in the FY26 Budget, when the government adopted its new debt-to-GDP target of 50 per cent by FY31.
The government’s debt roadmap assumes nominal GDP growth of 10-11 per cent annually, alongside moderate-to-high fiscal consolidation.
The starting point itself has proved weaker than expected. Nominal GDP expanded barely 9 per cent to ₹346.36 trillion. To reach the Budget estimate of ₹393 trillion in FY27, nominal GDP will need to grow by about 13.5 per cent this fiscal.
At the same time, the government is staring at a tight fiscal space in FY27 due to a likely expenditure overshoot on food and fertiliser subsides and a revenue shortfall of over ₹1.3 trillion after special additional excise duty cuts on fuel and tax exemptions for foreign portfolio investors (FPIs).
The strain is visible in the fiscal numbers. The government has already exhausted nearly a quarter of its full-year fiscal deficit target in the first month of FY27.
Any further slippage in the deficit target will need additional financing, most likely through higher borrowing, pushing the debt stock beyond the FY27 estimate of ₹218.63 trillion.
While some fiscal slippage is likely in FY27, some economists also expect subsidy rationalisation leading to stronger consolidation in the years ahead. “It’s still too early to jump to any conclusion on the debt reduction target,” Bank of Baroda Chief Economist Madan Sabnavis said.
Two of the four years remaining in the debt reduction roadmap will coincide with events that typically put pressure on government finances: the implementation of the Eighth Central Pay Commission and the Lok Sabha elections in 2029.
The implementation of the Eighth Pay Commission could add to the pressures on the government’s debt reduction roadmap. Pay commissions, constituted roughly once a decade, tend to raise revenue expenditure. Implementation of the 7th Central Pay Commission added an estimated ₹1 trillion annually to the government exchequer’s expense.
But experts also believe that a pay hike for central government employees following the rollout of the pay commission’s recommendations may provide some support to economic growth. “Tax buoyancy may potentially improve in FY28 due to better growth, leading to stronger revenue mobilisation for the government,” Sabnavis pointed out.
Elections present a different challenge. Governments often face pressure to announce welfare measures and other spending programmes ahead of a national poll.
However, if history is anything to go by, the general election may not complicate the fiscal consolidation in FY30. In the FY25 Interim Budget, presented ahead of the 2024 general election, Finance Minister Nirmala Sitharaman largely stayed the course on fiscal consolidation. The Model Code of Conduct also slowed capital expenditure in the initial months of FY25, due to which the government accumulated cash balances that were used to hold debt buyback auctions and prepay a portion of outstanding liabilities.
The obvious question is why the government is placing so much emphasis on a debt target when it has already succeeded in sharply reducing the fiscal deficit. The answer lies in the growing focus of investors and rating agencies on India’s debt burden.
Having reduced the fiscal deficit from 9.2 per cent of GDP in FY21 to 4.4 per cent in FY26, the government shifted its primary fiscal anchor from the deficit to the debt-to-GDP ratio. The move was widely seen as an attempt to address concerns over India’s elevated public debt levels and create a clearer medium-term fiscal framework.
The Centre’s own debt roadmap is also intended to encourage states to pursue similar consolidation.
According to the International Monetary Fund, India’s general government debt including the share of centre and states was 83 per cent of GDP in 2023 and is projected to decline to 78.4 per cent by 2029.
While S&P Global upgraded India’s sovereign rating to BBB from BBB- last year, Fitch Ratings and Moody’s Ratings continue to rate the country at BBB- and Baa3, respectively. According to Fitch, the median debt-to-GDP ratio for countries in the BBB category is 58.3 per cent.
Bringing debt down also has direct budgetary benefits. More than 30 per cent of the Centre’s revenue expenditure is currently absorbed by interest payments.
The debt target of the government is not merely a fiscal metric. Rather, it is an attempt to create room for future spending while strengthening India’s case for higher sovereign ratings. The challenge is that the journey has become considerably steeper than the government had anticipated just a year ago.
The current fiscal framework is not sufficient for debt consolidation, according to Madras School of Economics Director N R Bhanumurthy. “The government needs to also focus on lowering the revenue deficit as prescribed in the original Fiscal Responsibility and Budget Management (FRBM) Act of 2003,” he said.
The FRBM Act of 2003 had set an ambitious goal of eliminating the central government’s revenue deficit by March 2008. The Act was later amended in 2018, and the revenue deficit aim was relaxed.
Source: Business Standard
