Public debt

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

Meaning

Public debt (also called government debt) is the total amount of borrowing the government still owes at a point in time. It is a stock. The fiscal deficit (the government's extra borrowing in one year) is a flow, and each year's deficit adds to this stock.

• Basic link: Debt at year-end ≈ Debt at start of year + Fiscal deficit of that year
• 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
• Δd = change in the debt ratio in one year

Why it matters:

• Interest on old debt is itself spending, so debt can feed on itself.
• Whether debt is safe or a danger depends on how fast the economy grows compared with the interest rate the government pays.

Explanation

How public debt builds up

• Three ways to pay for a deficit:
• taxation (take more from people now);
• borrowing (sell bonds now and repay later);
• printing money (the central bank creates new money).

• Governments mostly borrow. That borrowing becomes public debt.

• Stock vs flow example:

• Debt at the start of the year = ₹100 lakh crore.
• Fiscal deficit that year = ₹15 lakh crore.

• Debt at year-end ≈ ₹115 lakh crore.

• Debt snowball (debt feeding on itself):

• old debt → interest must be paid → interest is spending, so the deficit rises;
• more borrowing → bigger debt → even more interest next year.

• Example: debt of ₹100 at 8% means ₹8 interest. If the government borrows to pay it, debt becomes ₹108. Next year's interest is ₹8.64.

• A government is not a trader:

• A trader must repay from their own income.
• A government can tax and can print money, so its debt can't be judged like a household's debt.

• NCERT: "the whole must be treated differently from the part".

• Scale matters:

• Debt is judged against the size of the whole economy.
• So we use the debt-to-GDP ratio (debt ÷ GDP, in per cent), not the rupee amount.
• This ratio is the key sign of whether a government can service its debt (pay the interest) and repay it.

Is public debt a burden?

• The case that it is a burden:
• Future generations pay: bonds sold today are repaid, say, 20 years later from taxes on the young at that time. Their disposable income (income left after taxes) falls, so they consume less.
• Less private capital: government borrowing uses up savings that firms could have borrowed. Private capital formation (new factories, machines, roads) falls, and growth falls with it.

• Clash with intergenerational equity: intergenerational equity means fairness between present and future generations. It is an explicit objective of the FRBM Act 2003.

• Counter-argument: "we owe it to ourselves":

• Domestic debt is held by Indian citizens, banks and institutions.
• Repayment moves money from Indian taxpayers to Indian bondholders.

• Resources shift between generations, but purchasing power stays inside the nation.

• External debt is a definite burden:

• Interest and principal owed to foreigners must be paid in foreign currency.

• This means real goods must be sent abroad as exports.

• Productive debt is not a burden:

• Suppose the government borrows ₹100 at 7%, so it pays ₹7 interest a year.
• The project raises GDP and tax revenue enough to yield 12%, or ₹12 a year.
• The debt pays for itself.

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

• Crowding out (government borrowing pushing out private investment):

• Government bonds compete with company bonds for a fixed pool of savings.
• The government borrows more → less saving is left for firms → interest rates rise → private investment falls.
• NCERT rebuttal: the pool of savings is not fixed. If deficits raise output when there is spare capacity, income rises → saving rises → both the government and industry can borrow more.

• Crowding in: public investment in roads, power or ports makes private projects more profitable, so firms invest more.

• Ricardian equivalence (David Ricardo's idea, revived by Robert Barro in 1974):

• Households are forward-looking and care about their children. The family is a dynastic unit, a chain of generations.
• They know that borrowing today = taxes tomorrow, so they save the whole of any tax cut paid for by borrowing.
• Private saving rises by exactly as much as government saving falls. National saving does not change, so debt-financed and tax-financed spending have the same effect.
• Example: your tax is cut by ₹1,000. The government borrows ₹1,000 at 8% and will tax you ₹1,080 next year. The present value (today's worth of a future amount) of that tax is 1,080 ÷ 1.08 = ₹1,000. So you save the full ₹1,000.
• Why it fails in practice: myopia (people don't look far ahead), liquidity constraints (poor households spend any tax cut, which matters a lot in India) and finite horizons (not everyone has heirs, or cares about them).

What makes the debt ratio rise or fall

• Two drivers of debt sustainability:
• Debt sustainability means the ability to meet all debt payments without default, and without impossible tax hikes or spending cuts.
• The primary balance: the primary deficit = fiscal deficit − interest payments. It is the borrowing for current spending only, leaving out interest on old debt.

• The growth-interest gap (r − g).

• Worked example 1 (g > r): the debt ratio falls

• d = 56%, r = 7%, g = 10%, primary deficit = 1% of GDP.
• (0.07 − 0.10) / 1.10 × 56 = −1.53 points.
• Δd ≈ −1.53 + 1.0 = −0.53.

• The ratio falls to about 55.5%, even with a primary deficit.

• Worked example 2 (r > g): the debt ratio snowballs

• r = 10%, g = 7%, same d and primary deficit.
• (0.03 / 1.07) × 56 = +1.57.

• Δd ≈ 1.57 + 1.0 = +2.57, so the ratio rises fast.

• Domar condition (after Evsey Domar):

• When g > r, the debt ratio can stay stable or fall even with modest primary deficits.

• A threshold exists:

• Beyond a certain level, more debt starts to lower growth.
• RBI research found this happens mainly through pressure on long-term interest rates, which cuts private investment and capital accumulation. [4]

In India

• Legal and constitutional base:
• The Budget is laid before Parliament under Art. 112.

• Borrowing limits come from the FRBM Act 2003 (Fiscal Responsibility and Budget Management Act).

• FRBM targets:

• The FRBM Review Committee (Chair: N.K. Singh, 2017) recommended making debt the anchor.
• The 2018 amendment to the FRBM Act set, for 2024-25:
  • general government debt (Centre + states, excluding what they owe each other) at 60% of GDP;
  • central government debt at 40% of GDP. [5]

• These targets were not met. The Centre's debt was still about 56% of GDP in 2025-26 RE, so the anchor has moved to a 50 ± 1% glide path (a planned year-by-year path) for 2030-31. [2][5]

• Union Budget 2026-27:

• The debt-to-GDP ratio is the main fiscal anchor, meaning the main target that guides policy.
• The fiscal deficit is the operational target, meaning the number managed year to year. [2]
• Centre's debt: 55.6% of GDP (2026-27 BE), down from 56.1% (2025-26 RE). [2]
• Fiscal deficit: 4.3% of GDP (2026-27 BE); 4.4% (2025-26 RE). [2]

• Target: 50 ± 1% of GDP by 2030-31. [2]

• RBI evidence on the debt threshold:

• An RBI Occasional Paper (2014) estimated a threshold of 61% of GDP for India's general government debt.
• Actual debt was 66.0% (March 2013), above that threshold. [4]
• India's r − g gap has been favourable, but it has "gradually narrowed down".

• The RBI study found only two years of primary surplus (2006-07 and 2007-08) in its study period. [4]

• IMF view:

• In its Article IV report, the IMF expects the favourable growth-interest differential to continue for the foreseeable future.

• It says debt stability rests on a largely unchanged primary deficit and a favourable r − g. [6]

• SLR pre-emption:

• SLR (Statutory Liquidity Ratio) is the share of deposits that banks must keep in safe assets, mainly G-secs (government securities).

• So the law reserves part of bank funds for government debt, which adds to crowding out.

• External debt (the whole country's debt to foreigners, not only the government's), end-March 2026:

• US$ 762.8 billion, or 20.8% of GDP, up from 19.8% at end-March 2025. [3]
• General government owes only US$ 167.5 billion (22.0%). The other 78.0% is owed by non-government borrowers such as companies and banks. [3]
• Forex reserves cover 90.6% of external debt. [3]
• Debt service (repayments plus interest) was 5.8% of current receipts in 2025-26, down from 6.6% in 2024-25. [3]

• Short-term debt is 19.6% of the total, and US dollar debt is 55.5%, so a weaker rupee raises the burden. [3]

• Lesson of 1991:

• In the 1980s, even foreign borrowing was used for consumption, not investment.
• 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, on the condition that it liberalise the economy. This became the New Economic Policy (NEP).

Don't confuse with

• Fiscal deficit: a flow, the borrowing in one year. Public debt is the stock that all past deficits have built up.
• Primary deficit: fiscal deficit minus interest payments. It shows new borrowing for current needs. Public debt includes all past borrowing.
• External debt: the whole country's borrowing from foreigners, by the government, companies and banks. Only 22.0% of it is general government debt (end-March 2026). [3] Most public debt is domestic.
• Central government debt vs general government debt: the first is the Centre alone (FRBM 2018 target 40%). The second is Centre + states (target 60%). [5]

Prelims Hooks

• Public debt = stock; fiscal deficit = flow. Each year's deficit adds to the debt.
• Domar condition: g > r (nominal growth above the interest rate). The debt ratio can fall even with a small primary deficit. Formula: Δd ≈ [(r − g)/(1 + g)]·d + primary deficit.
• FRBM 2018 amendment (N.K. Singh Committee): general government debt 60% and Centre 40% of GDP by 2024-25. [5]
• Budget 2026-27: debt-to-GDP is the anchor and fiscal deficit the operational target. Centre's debt is 55.6% of GDP (BE), with a target of 50 ± 1% by 2030-31. [2]
• Ricardian equivalence (Ricardo, revived by Robert Barro): a tax cut paid for by borrowing is fully saved, so national saving is unchanged. It fails under myopia, liquidity constraints and finite horizons.
• Trap: "Crowding out assumes a fixed pool of savings." That is correct, and it is the very assumption NCERT rejects when output can expand.

Mains Points

• Is public debt a burden?
• Domestic debt mostly moves money within the nation.
• External debt, and debt that lowers future growth, are real burdens.

• Capital spending that earns more than the interest rate pays for itself. This justifies a high share of capex within a shrinking fiscal deficit, and it can crowd in private investment.

• Sustainability rests on r < g:

• India's glide path to 50 ± 1% by 2030-31 needs growth to stay above borrowing costs. [2][6]
• Risks: a global interest-rate shock, a growth slowdown, or lasting primary deficits (only two surplus years in the RBI study period). [4]

• Answer: build primary surpluses and deepen the bond market.

• Intergenerational equity and fiscal rules:

• The missed FRBM 2024-25 debt targets show that fiscal rules need credible anchors and escape clauses. [5]
• The 1991 crisis shows what happens when borrowing pays for consumption.
• Link to twin deficits, a fiscal deficit and a current account deficit at the same time: (S − I) + (T − G) = (X − M).

Related concepts

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

Read more

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