Interest payments

Topic: Government Budget, Fiscal Policy and FRBM · NCERT: Class 12, Ch 5 "Government Budget and the Economy"

Meaning

Interest payments are the money the government pays every year as interest on what it has borrowed in the past. This covers market loans (such as government bonds), external loans (from foreign lenders) and money held in various reserve funds and deposits. For the Union government, interest is the largest single item of revenue expenditure (revenue expenditure is spending that creates no asset for the Centre).

This matters because interest is a committed cost: the government cannot skip it. The bigger the interest bill, the less money is left for health, education and capital expenditure. It also links the fiscal deficit to the primary deficit:

Primary deficit = Fiscal deficit − Interest payments

Explanation

Why interest is revenue expenditure

• The test for capital expenditure: does the spending create an asset, or reduce a debt, for the Centre itself?
• Interest fails this test. It is only the cost of borrowing in the past. No asset is created, and the debt stays the same size.
• PRS gives salaries and interest payments as examples of revenue expenditure [2].
• The classic pair on the same loan:
• Interest paid on the loan → revenue expenditure.

• Repayment of principal (paying back the original amount) → capital expenditure, because it reduces a liability (a debt the government owes).

• Under the old plan/non-plan system, interest was classed as non-plan expenditure. That classification was abolished from 2017-18 [3][4]. Today interest appears under "Other expenditure" within the Centre's own expenditure [2].

What it is paid on

• Market loans: bonds and treasury bills the government sells to banks, insurance companies and other investors.
• External loans: money borrowed from foreign governments and international institutions.
• Reserve funds and deposits: money the government holds on behalf of others (for example, provident fund-type deposits). It owes interest on these.

What makes it rise or fall

• Borrowing increases the interest bill:
• The government runs a fiscal deficit (it spends more than it earns and borrows the gap).
• Each year's borrowing adds to the stock of debt.

• A larger debt means a larger interest bill every year after that.

• Crises push it up, and it stays up. This is the Peacock-Wiseman displacement effect (spending jumps in a crisis and does not fall back):

• Heavy borrowing during COVID-19 pushed interest to a peak of 42% of revenue receipts in 2020-21 [2].

• The debt taken on then keeps the interest bill high for years.

• It falls only through steady fiscal consolidation (cutting deficits and debt step by step). Smaller deficits mean less new debt, so the interest bill grows more slowly.

Worked example

• Share of total expenditure (2026-27 BE, from [2] figures):
• Interest = ₹14,03,972 crore; total expenditure = ₹53,47,315 crore.

• 14,03,972 ÷ 53,47,315 ≈ 26%, so about one rupee in every four the Centre spends goes on interest.

• Primary deficit (worked out from [2] figures):

• Fiscal deficit (2026-27 BE) = ₹16,95,768 crore (4.3% of GDP) [2].
• Minus interest = ₹14,03,972 crore.
• Primary deficit ≈ ₹2,91,796 crore, or roughly 4.3% − 3.6% ≈ 0.7% of GDP.
• What this means: most of this year's borrowing goes only to pay interest on old borrowing.

In India

• Legal base: under Art. 112, the Budget (the Annual Financial Statement) shows interest on the revenue account.
• Rule framework: the FRBM Act 2003 sets limits on deficits and debt. These limits are the main tool for controlling the future interest bill.
• Latest size: ₹14,03,972 crore in 2026-27 BE, up 10.2% from ₹12,74,338 crore in 2025-26 RE [2].
• Share of the Budget (2026-27 BE):
• 26% of total expenditure [2].

• 40% of revenue receipts [2]. The NCERT-based range was 37-40%.

• Trend: interest as a share of revenue receipts went from 37% (2013-14) to 42% (2020-21), and is estimated at 40% in 2026-27 [2].

• Share of GDP: NCERT Table 5.1 gives 3.6% of GDP. A rough check with 2026-27 BE figures (GDP about ₹394 lakh crore) also gives about 3.6%.
• Part of committed expenditure: salaries, pensions and interest together take about 65.3% of revenue receipts (2026-27 BE) [2].
• Debt path: central debt is 55.6% of GDP in 2026-27. The target is about 50% ±1% of GDP by March 2031 [2].

Don't confuse with

• Repayment of loan principal: this is capital expenditure because it reduces a liability. Interest on the same loan is revenue expenditure.
• Interest receipts: interest the Centre earns on loans it has given (for example, to states or PSUs). This is non-tax revenue receipt, not expenditure.
• Primary deficit: this is the fiscal deficit minus interest payments. It shows borrowing for current needs only. The fiscal deficit includes interest.
• Committed expenditure: this is the wider group (interest + salaries + pensions, about 65.3% of revenue receipts in 2026-27 BE [2]). Interest is only one part of it, though the largest.

Prelims Hooks

• Interest payments are the largest single item of revenue expenditure of the Union government. They were earlier classed as non-plan expenditure.
• Trap: interest paid → revenue expenditure; repayment of principal → capital expenditure.
• Primary deficit = Fiscal deficit − Interest payments. A primary deficit of zero means all borrowing goes only to pay interest.
• 2026-27 BE: interest = ₹14,03,972 crore, 26% of total expenditure and 40% of revenue receipts [2].
• Interest/revenue receipts: 37% (2013-14) → peak of 42% (2020-21) → 40% (2026-27 BE) [2].
• NCERT Table 5.1: interest = 3.6% of GDP.

Mains Points

• Interest crowds out development spending.
• About 40% of revenue receipts go on interest (2026-27 BE) [2].
• With salaries and pensions added, committed spending takes about 65.3% [2].

• This leaves only about one-third of revenue income for schemes, subsidies and capex before the government has to borrow again.

• Debt and interest feed each other.

• High deficits → more debt → a higher interest bill → bigger deficits.

• Breaking this cycle needs rule-based fiscal consolidation under the FRBM Act 2003, with debt brought down from 55.6% (2026-27) to about 50% ±1% of GDP by March 2031 [2].

• Quality of borrowing matters.

• Borrowing spent on capex (₹12.2 lakh crore, about 3.1% of GDP in 2026-27 BE [2]) can raise future growth and tax revenue, which helps pay the interest.
• Borrowing spent on revenue items leaves the interest bill with no asset behind it.
• The COVID-era jump in interest to 42% of revenue receipts (2020-21) [2] shows how crisis borrowing locks in a lasting cost.

Related concepts

• Revenue expenditure
• Capital expenditure
• Plan and non-plan expenditure
• Committed expenditure
• Effective capital expenditure
• Social sector expenditure
• Welfare expenditure
• Wagner's law
• Peacock-Wiseman hypothesis

Read more

• Budget expenditure: revenue vs capital, committed spending and why spending grows