The document discusses the sustainability of public debt and fiscal deficits in India. It outlines three views on fiscal deficits - the neoclassical view, Keynesian view, and Ricardian equivalence perspective. It also discusses factors that affect debt sustainability like growth rates, interest rates, primary deficits, and financing of deficits. The document emphasizes the need to control deficits and debt to sustainable levels to avoid negative economic impacts and proposes various strategies to reduce fiscal deficits over time like expenditure rationalization and increasing revenues.

1. SUSTAINABILITY OF PUBLIC DEBT
SUBMITTED BY:
DEVENDER SINGH SAINI
(09HS2025)
IIT KHARAGPUR

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 common
Theoritical 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. THREE TYPES OF VIEW
Neoclasical view
Keynesian view of fiscal deficit
Ricardian equivalence perspective

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. 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. RICARDIAN EQUIVALENCE
PERSPECTIVE
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. Neoclassical Ricardian Keynesian
Consumers Finite lifetime Infinite time Myopic,
horizon perspective liquidity
constrained
Effects of a deficit Private saving Private saving Aggregate
based tax cut on would fall remains unaffected demand
private saving increases
Employment of Full employment Full employment Resources
resources not fully
employed
Effect on interest Interest rate No effect Interest rate
rate increases increases
Contention Fiscal deficits Fiscal deficits Fiscal
detrimental irrelevant deficits
beneficial

8. CHANNELS FOR FINANCING
DEFICIT
TYPES OF FINANCING EFFECT
EXTERNAL BORROWING PRESSURE ON EXCHANGE
RATE
BORROWING FROM PRESSURE ON INFLATION
CENTRAL BANK
DOMESTING BORROWING INTEREST RATE

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. CONTROLLING DEBT AND
DEFICIT
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 GDP
Main institutional reforms related to :
a) Formal deficit and debt rules.
b) Expenditure limit.
c) Requirement of transparency in fiscal management.

11. FRBMA 2003: INDIAN
CONTEXT
 OBJECTIVES:
1. Elimination of revenue deficit
2. 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. •Before the stablization phase is reached, the Indian economy will have to pass
through 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 level
lower than that, which will stablise the debt-GDP ratio at the previous year’s level.

13. SUSTAINABILITY OF DEBT AND FISCAL DEFICIT(DOMAR MODEL)
The standard equation for debt accumulation is written as
bt = pt + bt-1[(1+it)/ (1+gt)] (1)
Equation 1 can be written as
bt = pt + xtbt-1 [ where xt = (1+it)/ (1+gt)] (2)
If b0 = p0,
we have, b1 = p1 + x1 p0
b2 = p2+ x2p1 +x2x1p0
Generalising, we can write
bt = 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 write
bt = 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) = x
CASE I , g=i
t-1
bt = p + p ∑ (t+1) p (5)
t=0
bt = p(t+1)
If t is infinite
Then debt will also increase to infinite.
CASE II, g>i
bt = 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. CASE III, i>g
x>1
Debt will grow to infinity
Now, if we concentrate on CASE II
The 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 Growth
Rate
Vertical axis: debt-GDP ratio; Horizontal axis: fiscal deficit-GDP ratio

15. Another model
If pt is not constant
Let pt=j^t p0

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 by
f* = (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 rise
in 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 to
GDP, 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 fiscal
deficit and debt levels relative to GDP, the debt-GDP ratio and the fiscal deficit to GDP ratio will
eventually 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-GDP
ratio and fiscal deficit to GDP ratio together rather than only one of them.

17. Aspects of fiscal and debt
sustainability
•The long term fiscal stance requires additional information on the impact of debt
and deficit levels on growth, and the assumption of constancy of growth and
interest rates should be given up.
• In this case, the ratio of debt to GDP will rise progressively, even if the growth
rate is higher than the interest rate, if primary deficit to GDP ratio is above a
threshold level given by ps, which can be specified as dependent on previous
year’s debt-GDP ratio, growth rate and interest rate.

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 government's 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 country's 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. 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. 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. IMPACT OF FISCAL DEFICIT REDUCTION
Fiscal deficit reduction has an impact over the agricultural
sector and social sector.
Government's 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. Fiscal deficit v/s GDP growth

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. .
 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.