Debt sustainability

Also called: Fiscal sustainability · Topic: Government Budget, Fiscal Policy and FRBM · NCERT: Beyond NCERT

Meaning

Debt sustainability (also called fiscal sustainability) is the ability of a government to keep paying all its debt (interest and repayment) on time, without default and without impossibly large tax hikes or spending cuts. It depends on two things: the primary balance and the growth-interest gap (r − g).

It matters because if debt keeps rising faster than the economy, interest eats up the budget, private investment suffers and a crisis like 1991 can follow. The key formula is the debt dynamics equation:

Δd ≈ [(r − g) / (1 + g)] · d + primary deficit

• d = debt-to-GDP ratio
• r = nominal interest rate on the debt
• g = nominal GDP growth rate
• Δd = change in the debt ratio in one year (the primary deficit is also taken as % of GDP)

Explanation

1. Why we measure debt against GDP

• Public debt is a stock. It is the total amount the government still owes at a point in time.
• Fiscal deficit (total government spending minus total receipts other than borrowing) is a flow. It is the new borrowing in one year, and it adds to the stock of debt each year.

• Example: debt at the start of the year is ₹100 lakh crore and the fiscal deficit is ₹15 lakh crore. Debt at the end of the year is about ₹115 lakh crore.

• A bigger rupee figure for debt does not by itself mean danger. What matters is whether debt grows faster than the whole economy.

• So we use the debt-to-GDP ratio (debt ÷ GDP × 100). It shows whether the government can service its debt (pay interest) and repay it.

• A government is not a trader:

• A trader must repay from their own income.
• A government can raise taxes and, in the end, create money, so its debt is judged differently.
• Even so, a government can lose the trust of lenders if its debt grows without limit.

2. The two components

• Primary balance:
• Primary deficit = fiscal deficit − interest payments.
• It is the borrowing needed for all spending other than interest on old debt.

• A primary surplus means the government earns more than it spends apart from interest. That surplus pulls the debt ratio down.

• Growth-interest gap (r − g):

• r > g: interest makes the debt grow faster than GDP, so the ratio rises by itself. This is the debt snowball:
  • old debt → interest has to be paid → deficit rises → more borrowing → bigger debt → even more interest.
  • Example: ₹100 of debt at 8% → ₹8 interest. If that interest is paid by borrowing, debt becomes ₹108, and next year's interest is ₹8.64.
• g > r: GDP grows faster than the interest bill, so the ratio falls by itself. This is the Domar condition (named after Evsey Domar).
  • The debt ratio can stay steady or even fall with a small primary deficit.

3. Worked examples (same debt, same primary deficit)

• Case A: g > r (sustainable)
• d = 56%, r = 7%, g = 10%, primary deficit = 1% of GDP.
• Growth-interest effect: (0.07 − 0.10) / 1.10 × 56 = −1.53 points.
• Δd ≈ −1.53 + 1.0 = −0.53.

• The debt ratio falls to about 55.5%, even though the government ran a primary deficit.

• Case B: r > g (snowball)

• r = 10%, g = 7%, with the same d and primary deficit.
• Growth-interest effect: (0.03 / 1.07) × 56 = +1.57 points.
• Δd ≈ 1.57 + 1.0 = +2.57.

• The debt ratio rises every year unless the government runs a primary surplus.

• Lesson: the same budget can be safe or unsafe. The result depends on whether growth stays above borrowing costs.

4. What makes debt more or less sustainable

• Makes it better:
• Higher nominal growth (g).
• Lower interest rates (r).
• Smaller primary deficits, or primary surpluses.

• Productive debt. When borrowed money goes into projects that earn more than the interest rate, the growth they create pays back the loan.

  • Example: borrow ₹100 at 7% (₹7 interest a year). The project adds enough GDP and tax revenue to return 12% (₹12 a year). The debt pays for itself.

• Makes it worse:

• A rise in interest rates or a growth slowdown, which can turn g > r into r > g.
• Borrowing for consumption (day-to-day spending) instead of investment.
• External debt (debt owed to foreigners), which must be repaid in foreign currency. When the rupee weakens, this debt becomes heavier.

• Debt above a threshold, where extra debt starts to lower growth.

• NCERT view: debt is a burden only if it reduces future growth.

In India

• Legal framework: the FRBM Act 2003 (Fiscal Responsibility and Budget Management Act):
• It makes intergenerational equity (fairness between today's and future generations) an explicit objective.
• The FRBM Review Committee (Chair: N.K. Singh, 2017) recommended debt as the anchor, meaning the main target that guides fiscal policy.
• The 2018 amendment set general government debt (Centre + states, not counting what they owe each other) at 60% of GDP and central government debt at 40% of GDP, both by 2024-25. [4]

• These targets were not met. The Centre's debt was still about 56% of GDP in 2025-26 RE. [1][4]

• Current anchor (Union Budget 2026-27):

• The debt-to-GDP ratio is the main fiscal anchor. The fiscal deficit is the operational target, meaning the number managed year to year. [1]
• Centre's debt: 55.6% of GDP (2026-27 BE), down from 56.1% (2025-26 RE). [1]
• Fiscal deficit: 4.3% of GDP (2026-27 BE); 4.4% (2025-26 RE). [1]
• Medium-term target: 50 ± 1% of GDP by 2030-31, following a glide path (a planned year-by-year path). [1]

• The 16th Finance Commission projects combined Centre + states debt falling from 77.3% (2026-27) to 73.1% (2030-31) (figure to be checked against the latest data).

• The r < g assumption:

• India has had r < g in most recent years. The fiscal plan depends on this continuing.

• The IMF (2025 Article IV) expects the favourable growth-interest gap to continue. It says debt stability rests on a largely unchanged primary deficit and a favourable r − g. [5]

• Warning signs from the RBI:

• An RBI Occasional Paper (2014) estimated a debt threshold of 61% of GDP for India's general government. Above this level, more debt starts to lower growth. Actual debt was 66.0% (March 2013), above the threshold. [3]
• The same study found the r − g gap has "gradually narrowed down", and India had only two years of primary surplus (2006-07 and 2007-08) in its study period. [3]

• High debt hurts growth mainly by pushing up long-term interest rates, which cuts private investment. [3]

• External side:

• External debt stood at US$ 762.8 billion, or 20.8% of GDP, at end-March 2026, up from 19.8% at end-March 2025. [2]
• Only US$ 167.5 billion (22.0%) is owed by the general government. The other 78.0% is owed by companies, banks and other non-government borrowers. [2]
• Forex reserves cover 90.6% of external debt. Debt service (repayments plus interest) fell to 5.8% of current receipts in 2025-26, from 6.6% in 2024-25. [2]

• US dollar debt is 55.5% of the total, so a weaker rupee raises the burden. [2]

• 1991 lesson:

• In the 1980s, borrowing (including foreign borrowing) paid for consumption.
• By 1991, forex reserves covered only about two weeks of imports, and India could not pay interest to foreign lenders.
• India took a US$ 7 billion loan from the IMF and World Bank. The conditions attached led to the New Economic Policy.

Don't confuse with

• Fiscal deficit vs debt sustainability: the fiscal deficit is one year's flow of borrowing. Debt sustainability asks whether the stock of debt, taken as a ratio to GDP, can be kept stable or brought down.
• Primary deficit vs fiscal deficit: primary deficit = fiscal deficit minus interest payments. The sustainability equation uses the primary deficit, because the interest part is already captured in the (r − g) term.
• Domar condition vs debt sustainability: g > r helps a lot, but it is not enough on its own. A large primary deficit can still push the debt ratio up even when g > r.
• Total external debt vs sovereign external debt: India's external debt (US$ 762.8 bn, end-March 2026) is mostly non-government. The general government share is only 22.0%. [2]

Prelims Hooks

• Formula: Δd ≈ [(r − g)/(1 + g)]·d + primary deficit. Here r and g are nominal rates.
• Domar condition: nominal GDP growth g > r (interest rate). The debt ratio can fall even with a small primary deficit. The statement "a primary deficit always raises the debt ratio" is a trap.
• Budget 2026-27: debt-to-GDP is the anchor and the fiscal deficit is the operational target. Centre's debt is 55.6% (BE), with a target of 50 ± 1% by 2030-31. [1]
• FRBM 2018 amendment (N.K. Singh Committee): general government debt 60% and Centre 40% of GDP by 2024-25. These targets were missed. [4]
• RBI Occasional Paper (2014): debt threshold of 61% of GDP for India's general government. Actual debt was 66.0% (March 2013). Only two primary-surplus years (2006-07 and 2007-08) in the study period. [3]
• Trap: "Debt sustainability means debt must be zero or falling in rupees." This is wrong. What must stay stable or fall is the debt-to-GDP ratio.

Mains Points

• India's glide path rests on r < g:
• Reaching 50 ± 1% of GDP by 2030-31 needs growth to stay above borrowing costs. [1][5]
• The risks are a global interest-rate shock, a growth slowdown, or persistent primary deficits, since the RBI study found only two surplus years in its period. [3]

• The way out: move towards primary surpluses, deepen the government bond market and protect capital expenditure, because productive capex earns more than it costs.

• Quality of debt matters as much as quantity:

• Debt used for infrastructure can crowd in private investment and pay for itself.
• Debt used for consumption led to the 1991 crisis.
• High debt also pushes up long-term interest rates and crowds out private investment. [3]

• Link this to intergenerational equity under the FRBM Act and to twin deficits, where government dissaving widens the current account deficit.

• Fiscal rules need credibility:

• The missed 2024-25 FRBM targets show that fixed numeric limits can slip. [4]
• A clear debt anchor, a realistic glide path and transparent escape clauses make rules more believable. External buffers help too: reserves cover 90.6% of external debt and the sovereign share is only 22.0%. [2]

Related concepts

• Public debt
• Burden of debt
• Intergenerational equity
• Ricardian equivalence
• Crowding out
• Crowding in
• Inflationary effect of deficits
• Debt-to-GDP ratio
• Interest rate-growth differential
• Twin deficit

Read more

• Public debt: burden, Ricardian equivalence, crowding out and sustainability