SUSTAINABILITY OF PUBLIC DEBT                    SUBMITTED BY:                DEVENDER SINGH SAINI                      (0...
INTRODUCTION High level of fiscal deficit tends not only to cause sharp increase in  debt-GDP ratio, but also adversely a...
THREE TYPES OF VIEWNeoclasical viewKeynesian view of fiscal deficitRicardian equivalence perspective
NEOCLASSICAL VIEWNeoclassical model assumes full employment in the economy and have negative effect of deficit on growth....
KEYNESIAN VIEWAssume less than full employmentAs autonomous government expenditure increases, output increases(due to mu...
RICARDIAN EQUIVALENCEPERSPECTIVEAcc. to Ricardian equivalence perspective , fiscal deficits are viewed as neutral in term...
Neoclassical      Ricardian            KeynesianConsumers              Finite lifetime   Infinite time        Myopic,     ...
CHANNELS FOR FINANCINGDEFICIT TYPES OF FINANCING    EFFECT EXTERNAL BORROWING    PRESSURE ON EXCHANGE                     ...
SUSTAINABILITY Capacity to keep balance between costs of additional borrowing with return  from such borrowing . It coul...
CONTROLLING DEBT ANDDEFICITIt is important to provide exogenous limits on borrowing by   governments, whether central or ...
FRBMA 2003: INDIANCONTEXT OBJECTIVES:1. Elimination of revenue deficit2. Fiscal deficit to be bought at the level of 3% o...
•Before the stablization phase is reached, the Indian economy will have to passthrough an adjustment phase. During this ph...
SUSTAINABILITY OF DEBT AND FISCAL DEFICIT(DOMAR MODEL)The standard equation for debt accumulation is written asbt = pt + b...
CASE III, i>gx>1Debt will grow to infinityNow, if we concentrate on CASE IIThe fiscal deficit to GDP ratio (f*) correspond...
Another modelIf pt is not constantLet pt=j^t p0
the ratio of interest payments to GDP. Defining interest payments to GDP ratio as (ipy)b*= (ipy)* .(1+g)/i                ...
Aspects of fiscal and debt     sustainability•The long term fiscal stance requires additional information on the impact of...
FISCAL DEFICIT  Fiscal deficit is an economic phenomenon, where the government’s total expenditure  surpasses the revenue...
FISCAL DEFICIT AND INFLATION In order to relate high fiscal deficit to inflation, some economists  believe that the porti...
FISCAL DEFICIT AND INDIA In India , the fiscal deficit is financed by obtaining funds from Reserve Bank of India , called...
IMPACT OF FISCAL DEFICIT REDUCTIONFiscal deficit reduction has an impact over the agricultural sector and social sector....
Fiscal deficit v/s GDP growth
CONCLUSION The three ways to reduce the budget deficit are to cut non interest govt. outlays, to  increase tax revenue an...
. Raising revenue is the alternative way to reduce the primary deficit. The way  in which that revenue is raised in very ...
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Sustainability of public debt presentation. (1)

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Sustainability of public debt presentation. (1)

  1. 1. SUSTAINABILITY OF PUBLIC DEBT SUBMITTED BY: DEVENDER SINGH SAINI (09HS2025) IIT KHARAGPUR
  2. 2. INTRODUCTION High level of fiscal deficit tends not only to cause sharp increase in debt-GDP ratio, but also adversely affect savings and investment and consequently growth. India is certainly not alone in having budget deficits that are too high. Greece has 142% and Italy has 119% now have deficits that violate the European Growth and stability pact. Japan is having the highest debt-GDP ratio of 220%. Debt-to-GDP ratios of 100% is becoming commonTheoritical view There is no agreement among economist whether fiscal is good, bad or neutral in terms of it’s real deficit, particularly on investment and growth.
  3. 3. THREE TYPES OF VIEWNeoclasical viewKeynesian view of fiscal deficitRicardian equivalence perspective
  4. 4. NEOCLASSICAL VIEWNeoclassical model assumes full employment in the economy and have negative effect of deficit on growth.Taxes shift to future generation which raises life time consumption and which leads to reduction in saving.Due to revenue deficit government saving decreases and if this reduction in government saving is not compensated by increase in private saving , thereby resulting in fall in overall saving rate.National saving is financed by higher borrowing.
  5. 5. KEYNESIAN VIEWAssume less than full employmentAs autonomous government expenditure increases, output increases(due to multiplier process).If money supply is fixed and deficit is bond financed interest rate partially increases.But increase in interest rate is neutralized by increased profitability of investment.
  6. 6. RICARDIAN EQUIVALENCEPERSPECTIVEAcc. to Ricardian equivalence perspective , fiscal deficits are viewed as neutral in terms of their impact on economic growth.Deficit in current period is equal to the present value of future taxationAssume that decrease in current government saving may be accompanied by increase in private saving therefore investment and interest rate unchanged.Ricardian equivalence assert that fiscal deficits do not really matter except for smoothening the adjustment to expenditure or revenue shocks.
  7. 7. Neoclassical Ricardian KeynesianConsumers Finite lifetime Infinite time Myopic, horizon perspective liquidity constrainedEffects of a deficit Private saving Private saving Aggregatebased tax cut on would fall remains unaffected demandprivate saving increasesEmployment of Full employment Full employment Resourcesresources not fully employedEffect on interest Interest rate No effect Interest raterate increases increasesContention Fiscal deficits Fiscal deficits Fiscal detrimental irrelevant deficits beneficial
  8. 8. CHANNELS FOR FINANCINGDEFICIT TYPES OF FINANCING EFFECT EXTERNAL BORROWING PRESSURE ON EXCHANGE RATE BORROWING FROM PRESSURE ON INFLATION CENTRAL BANK DOMESTING BORROWING INTEREST RATE
  9. 9. SUSTAINABILITY Capacity to keep balance between costs of additional borrowing with return from such borrowing . It could be in the form of high growth resulting in higher government revenues that can be used for servicing the additional borrowing. Debt would become unsustainable, if fiscal deficits follow a course that leads to a self-perpetuating rise in the debt-GDP ratio, which affects negatively the growth rate and positively the interest rate, such that the existing levels of primary government expenditures cannot be sustained, given the configuration of growth and interest rates.
  10. 10. CONTROLLING DEBT ANDDEFICITIt is important to provide exogenous limits on borrowing by governments, whether central or subnational. Such limits can be exercised through fiscal responsibility legislations, or other institutional arrangements.EXAMPLE-criteria for europian monetary union:1) Budget deficit for each fiscal year ≤ 3% of GDP.2) Public debt ≤ 60% of GDPMain institutional reforms related to :a) Formal deficit and debt rules.b) Expenditure limit.c) Requirement of transparency in fiscal management.
  11. 11. FRBMA 2003: INDIANCONTEXT OBJECTIVES:1. Elimination of revenue deficit2. Fiscal deficit to be bought at the level of 3% of GDP ,with 0.3% point of GDP as the minimum annual reduction target. The FRBMA has some built-in flexibility in achieving revenue and fiscal deficit reduction targets as there is a provision that the specified limits may be exceeded on grounds of national security or national calamity or such other exceptional grounds. The Act has also provided that ‘Reserve Bank of India may subscribe to the primary issues to the Central Government Securities’ for specified reasons. State faces higher interest rate than centre, it allow a target unit of fiscal deficit relative to GDP for states as of centre so that it would result in same interest payment ratio as of centre.
  12. 12. •Before the stablization phase is reached, the Indian economy will have to passthrough an adjustment phase. During this phase, the debt-GDP ratio will have to fall.This can be done by reducing the fiscal deficit to GDP ratio each year to a levellower than that, which will stablise the debt-GDP ratio at the previous year’s level.
  13. 13. SUSTAINABILITY OF DEBT AND FISCAL DEFICIT(DOMAR MODEL)The standard equation for debt accumulation is written asbt = pt + bt-1[(1+it)/ (1+gt)] (1)Equation 1 can be written asbt = pt + xtbt-1 [ where xt = (1+it)/ (1+gt)] (2)If b0 = p0,we have, b1 = p1 + x1 p0b2 = p2+ x2p1 +x2x1p0Generalising, we can writebt = pt + (xt) pt-1+ (xtxt-1) pt-2+…. + (xtxt-1….x1) p0 (3)If it is assumed that xt is constant, implying g and i are constant for all t, We can writebt = pt + x pt-1 +x2 pt-2+…. +xt-1 pt-1+xt p0 (4)the additional assumption that p’s are also constant for all t. Since xt = (1+it)/(1+gt) = xCASE I , g=i t-1bt = p + p ∑ (t+1) p (5) t=0bt = p(t+1)If t is infiniteThen debt will also increase to infinite.CASE II, g>ibt = p {1 + x +x2+…. +xt-1 +xt} (6) bt = p + p x/ (1-x) = p/ (1-x)bt = p (1+g)/ (g-i) as t →∞ (7)
  14. 14. CASE III, i>gx>1Debt will grow to infinityNow, if we concentrate on CASE IIThe fiscal deficit to GDP ratio (f*) corresponding to a stable debt-GDP ratio (b*) will be:f*=p.g/ (g-i) (8)b*=f*.(1+g)/ g (9)Stable Combination of Debt and Fiscal Deficit to GDP Ratio for Different GrowthRate Vertical axis: debt-GDP ratio; Horizontal axis: fiscal deficit-GDP ratio
  15. 15. Another modelIf pt is not constantLet pt=j^t p0
  16. 16. the ratio of interest payments to GDP. Defining interest payments to GDP ratio as (ipy)b*= (ipy)* .(1+g)/i (10)The corresponding level of fiscal deficit to GDP ratio is given byf* = (ipy)* g/i (11)pt=bt-1[(gt-it)/(1+gt)= pst (12)Here, it is the average interest rate and pst is called the debtstabilising primary deficit to GDP ratio.As long as pt in any given year is equal to or less than pst for that year, debt-GDP ratio will not risein that year compared to its level in the previous year.The main lessons from the canonical model can be summarised as follows:•The debt-GDP ratio will rise continuously for positive values of the primary deficit relative toGDP, if the growth rate is equal to or less than the interest rate.•If growth rate is higher than the interest rate, and both of these are unaffected by the levels of fiscaldeficit and debt levels relative to GDP, the debt-GDP ratio and the fiscal deficit to GDP ratio willeventually stablise.•The system of equations implicit in the canonical model can define combinations of stable debt-GDP ratio and fiscal deficit to GDP ratio but does not determine their best or most desirable values.•In deciding a suitable fiscal stance for the medium to long run, it is best to consider the debt-GDPratio and fiscal deficit to GDP ratio together rather than only one of them.
  17. 17. Aspects of fiscal and debt sustainability•The long term fiscal stance requires additional information on the impact of debtand deficit levels on growth, and the assumption of constancy of growth andinterest rates should be given up.• In this case, the ratio of debt to GDP will rise progressively, even if the growthrate is higher than the interest rate, if primary deficit to GDP ratio is above athreshold level given by ps, which can be specified as dependent on previousyear’s debt-GDP ratio, growth rate and interest rate.
  18. 18. FISCAL DEFICIT  Fiscal deficit is an economic phenomenon, where the government’s total expenditure surpasses the revenue generated. It is the difference between the governments total receipts (excluding borrowing) and total expenditure. Fiscal deficit gives the signal to the government about the total borrowing requirements from all sources. The primary component of fiscal deficit includes revenue deficit and capital expenditure. The capital Expenditure is the fund used by an establishment to produce physical assets like property, equipments or industrial buildings. Capital expenditure is made by the establishment to consistently maintain the operational activities.   According to KEYNES, fiscal deficits facilitate nations to escape from economic recession. From another point of view, it is believed that government needs to avoid deficits to maintain a balanced budget policy.  According to Keynesian, running a fiscal deficit and increasing government debt can initially stimulate economic activity only when a countrys output (GDP) is below its potential output. But when an economy is running near or at its potential level of output, fiscal deficits can cause high inflation. At that point FISCAL DEFICIT MUST BE CONTROLLED
  19. 19. FISCAL DEFICIT AND INFLATION In order to relate high fiscal deficit to inflation, some economists believe that the portion of fiscal deficit, which is financed by obtaining funds from the Reserve Bank of India , directs to rise in the money stock and a higher money stock eventually heads towards inflation. In India actually this has happened now.
  20. 20. FISCAL DEFICIT AND INDIA In India , the fiscal deficit is financed by obtaining funds from Reserve Bank of India , called deficit financing. The fiscal deficit is also financed by obtaining funds from the money market (primarily from banks).  Confederation of Indian Industry (CII) stressed on the importance of reducing the fiscal deficit to 5 per cent (of GDP) over the next fiscal versus the current level of . It advised the Ministry of Finance to aim at maintaining and further accelerating the recovery process, along with focusing on correcting the fiscal deficit which is at an undesirable level. Now the question is HOW? It could be reduced by rationalization of expenditure, augmentation in revenue, disinvestment of public sector undertaking, enhancing the efficiency of funds spent on various flagship programs like NREGA among others and efficient management of funds in different government programme. CII suggested a system through which Rs 50,000 crore from Rs 2 lakh crore, held up in various disputes and litigations for a long time, could be unlocked by resolving one quarter of the existing disputes. CII suggests measures such as facilitating negotiations, out of court settlement, establishing fast trials Court to achieve this.  Rs 40,000 crore can be raised through disinvestment. And the revenues from both these measures, along with that from higher tax collection.
  21. 21. IMPACT OF FISCAL DEFICIT REDUCTIONFiscal deficit reduction has an impact over the agricultural sector and social sector.Governments investments in these sectors may have to be reduced , or alternatively new source of revenue generation must have to be sought through large disinvestments. 
  22. 22. Fiscal deficit v/s GDP growth
  23. 23. CONCLUSION The three ways to reduce the budget deficit are to cut non interest govt. outlays, to increase tax revenue and to reduce rate of interest on govt debt. It is necessary to slow the growth of non interest spending to less than the growth of the GDP US succeeded in reducing the ratio of non interest outlays to GDP from 20.8% of GDP in 1980 to 19.41% of GDP in 1988 In many emerging markets countries stopping support for money losing state owned enterprises by imposing a hard budget constrain or by privatizing the entity can be a major source of spending reduction.
  24. 24. . Raising revenue is the alternative way to reduce the primary deficit. The way in which that revenue is raised in very important. An increase in the tax on labor income or investment incomes can entail large deadweight losses. That form of tax can also reduce the rate of economic growth. Another best strategy is to find ways to reduce loopholes that allow technically legal but unjustifiable tax avoidance. Charges for government services can be an important source of revenue, especially in an economy like India where the government provides such a wide range of public services. The government can reduce that interest rate, it can do so indirectly by a sound monetary policy that reduces inflation risk can reduce the real interest rate.
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