India pays one of the highest interest rates in the world on its debt, but shows no signs of curbing its borrowingWritten by Rishabh Srivastava on Feb 29 | [email protected]
This is the final post in a three-part series that explains how India's budget works. If you haven't read the first two parts yet, I strongly recommend checking them out first. The first part talks about how the Indian government raises revenue, while the second part talks about where it spends taxpayer's money.
This post talks about the balance that India must find between populist policies, spending on development, and paying off its debts. India's dire debt situation has not received much attention in the media, but needs to be resolved quickly.
India is in a tight financial spot
India's current financial situation is similar to someone who spends 70k per month, earns 50k per month, and uses his credit card to fund the remaining 20k. Clearly, it is not a good financial situation to be in. In 2015-16, India spent more than 1.4x what it earned, and borrowed money to finance the deficit. In fact, the situation is so bad that the government now has to borrow more money to pay off its old loans , a situation that is known as a debt trap.
To be fair, India's financial situation has improved somewhat in recent years. 5 years ago, it was spending around 1.65x what it earned. Indian politicians and policy-makers often refer to India's lower Debt-to-GDP ratio compared to western countries as a sign that things are not too bad. But they forget that other countries borrow money at a much lower rate compared to India, and while they can afford high debt, India can't.
In view of this, it is imperative that India stop its reliance on debt soon, we just can't afford it. To do this, the government must either increase tax revenue or reduce expenditure. Sounds easy enough, but both of these options present their own challenges.
Tax evasion leads to low revenue from direct taxes
India has a very high rate of tax evasion , which makes it difficult for the government to collect what it is owed. At the same time, it is politically infeasible for the government to increase the tax-rate for the middle class (which is already amongst the highest in Asia). It is also difficult for the government to increase corporate taxes further, as that will make the country less attractive as an investment destination. Indian Corporate taxes are already among the highest in Asia.
While the government announced its intention to bring these down to 25% last year , no action has been taken in this regard.
Unable to get people to pay fair taxes and unable to raise taxes further, the government has instead increased indirect taxes. Service taxes have gone through the roof, and excise duties increased sharply last year. As a consequence, benefits of falling oil prices have not been passed down to the consumer.
Political reasons mean that it is hard to reduce expenditure
In order to reduce its expenditure by any significant margin, India must cut down on its two largest expense heads after interest payments - defence expenditure, and food and fertilizer subsidies. However cutting down on either will be wildly unpopular, and the government is unlikely to do either anytime soon. If Budget 2016-17 is any indication, populism is here to stay.
Spending in itself is not bad. Indeed, spending on infrastructure and education will likely pay for itself in the near future. However, very little of India's expenditure goes into these.
India must tread very carefully as it moves forward. Many experts have raised doubts over the validity of India's GDP figures, and if the country's growth rate is not maintained, it could risk falling even further in the debt trap.
It's okay for someone to borrow 20k per month on an income of 50k per month if he expects his income to increase to 100k in a few years. But if his income does not increase, he will be faced with a huge amount of interest payments. The story is similar for India.
The country went through a lot of hardship to reduce it's debt burden over the last two decades. It must make sure that it remains cautious and does not raise it's debt levels beyond what it can handle.
And this, in summary, is a simplified overview of the Indian budget. I hope that you enjoyed reading this series. If you have further questions, or would like to give feedback about this post, please drop me a line at [email protected]