Interest rate-growth differential
Also called: r-g differential · Topic: Government Budget, Fiscal Policy and FRBM · NCERT: Beyond NCERT
Meaning
The interest rate-growth differential (r − g) is the gap between the interest rate on government debt (r) and the growth rate of nominal GDP (g), which is GDP growth including price rises. It decides whether the debt-to-GDP ratio (d) snowballs or shrinks:
Δd ≈ [(r − g)/(1 + g)]·d + primary deficit
When g > r (the Domar condition), the first term is negative. The economy grows faster than interest piles up, so the debt ratio can stay stable or fall even with a modest primary deficit (the deficit excluding interest payments). When r > g, debt grows faster than the economy.
Example
India has had r < g in most recent years. This is a key assumption behind the plan to bring the Centre's debt from 55.6% of GDP (2026-27 BE) to 50 ± 1% by 31 March 2031. If interest rates rose above growth, the debt ratio could snowball.
Don't confuse with
- Fiscal deficit: a yearly flow of borrowing. The r − g differential is about how fast the stock of existing debt grows relative to the economy.
Related concepts
- Public debt
- Burden of debt
- Intergenerational equity
- Ricardian equivalence
- Crowding out
- Crowding in
- Inflationary effect of deficits
- Debt-to-GDP ratio
- Debt sustainability
- Twin deficit