Law Insider India

Legal News, Current Trends and Legal Insight | Supreme Court of India and High Courts

Analysis on Borrowings by Government of India

9 min read
government borrowings Law Insider

By Mohammed Asif

Published On: February 06, 2022 at 10:30 IST

Introduction

During recent times, public debt in India has grown tremendously and public debt reduces the economic growth. To raise the productive capacity of the country, it is necessary that the resources raised by the Government through borrowing need to be productively used on developmental activities. The importance of prudent fiscal management and debt management to assess the vulnerability of the Government’s debt possession is required to eradicate the financial and debt crisis.

What is Government Borrowing?

A loan taken by the Government to spend on public services and benefits which fall under the capital receipt in Budget document is known as Government borrowings. Government borrowings can be classified into:

  • Seigniorage: It is a borrowing that enables the government to acquire resources without incurring liability to repay the loan or to pay interest.
  • Public debt: Public debt is the total amount including total liabilities which the government borrows to meet the developmental budget. Public debt needs to be from the Consolidated Fund of India.

Borrowings of the Government from the Reserve bank of India do not involve any liability to repay, but the interest on the debt is paid by the government.

Sources of Government Borrowing

The following are the Sources of the government borrowings that can be classified as:

  • Government securities (G-Secs)
  • Treasury bills
  • External assistance
  • Short term borrowings

Objectives of Government Borrowings

  • The Government’s income reduces because of unexpected events such as floods, earthquakes, communicable diseases, famine, as a result increasing administrative expenditure, thus to recover such problems the government takes debt.
  • When the country is in a depression, to overcome such a phase the government increases the expenditure of public construction work and infrastructure services.
  • To remove inflation in the country the unused taxes can be debited from the government fund to reduce the pressure from the production in the economy.
  • The government takes the public debt to finance developmental plans which can eradicate poverty from the country.
  • The government takes debt from inside and outside of the country for self-defense services.
  • The government borrowing is done for the development of education and health services and also for many other services.
  • A large amount of money is required for the government to establish and fulfill the needs of every citizen of the country.

Why does the Government borrow money?

The government borrows money when the local income of the government becomes insufficient for public expenditure because at that point it becomes impossible for the government to increase the tax income. When the current revenue of the government of India is insufficient to achieve the target, the government borrows finance arrangement of capital expenditure.

Causes of Borrowing

  • As a large number of financial resources are required to fulfill the five-year plans in India, the government takes public debt.
  • When the public income is misused due to corruption, bribes, and red-tapism it becomes a burden on the government to fulfill the requirement of the public.
  • Due to the burden of indirect taxes and imperfect tax system, it increases the pressure on the government.

How does the Government borrow money?

The government borrows money in the form of debt. Borrowings can be done through G-Secs, treasury bills, external assistance, and short-term borrowings. The purchase of these securities by investors, financial institutions, companies, and even other state governments gives the money the government seeks to borrow.

The government of India is also on the hook to pay the interests for the public debt. These payments form a significant part of the fiscal deficit (deficit between government expenditure and the revenue in a year) the information regarding the public debt will be found under the capital receipt under the budget document. Government always keeps a check on their fiscal deficit by consolidating their past debt obligations which is the reference in terms of national GDP percentage to understand the real scale.

How to reduce the burden on Government?

The following are the measures to reduce the burden:

  • Reducing public expenditure and increasing revenues: As a rapidly developing economy like India, the rise in public expenditure is increasing every year. The government of India has to increase the capital expenditure- GDP ratio over the years to reduce fiscal deficit but this is not desirable because decline in capital expenditure has the potential to disrupt the growth process. The best strategy would be to seek a better way to increase collection with existing law by reducing tax evasion and to find a way to reduce the loopholes that allow technically legal but unjustifiable tax avoidance. An important source of revenue for the government of India would be charges for government services as far as non-tax revenue is concerned.
  • Reduction in the Interest rate: Decrease in the interest on the public debt can help reduce the burden of government borrowing and in bringing down the debt-GDP ratio. A sound monetary policy can help t9o reduce the real interest rate which will also reduce inflation risk.
  • Selling contraband gold to retire debt: A substantial part of the gold reserve which is created by confiscating contraband gold which came through smuggling through large quantities can be sold in auction and those proceeds can be used to retire the public debt.
  • Using amount realized from this investment: The main rationale behind this investment program which the government of India has been pursuing since 1991-92 is to increase resources and utilize those resources generated from the disinvestment for bringing down fiscal deficit. As per the analysis from 1991-92 till march 31st 2018 the total receipts from various rounds of disinvestment amounted to INR 3,47,440 crores.
  • Selling a part of vast real-estate to raise resources: The Government of India has vast part of real-estate in particular railways which holds large amounts of land along and around rail tracks; use of the amounts of selling those parts can generate income to retire public debt.

Debt redemption and its methods

Redemption of public debt means repayment of the debt taken by the Government of India. Usually the government searches for an opportunity to postpone the debt taken. The payment of the debt in the earliest manner is necessary to save future payment from the burden of tax.

The following are the methods of repayment:

  • Debt redemption: It means to deny the payment of debt taken by the government, usually this step is considered as discriminatory and inconsistent because it shutters the faith of the people and banks.
  • Refunding: It is the process by which new bonds are changed in place of maturing bonds. It will happen when the interest rate is low and to change the maturity rate of the remaining debt of the government.
  • Convection of debts: It means changing old debts to new debts to reduce the burden of taxes, the government takes debt when the interest rate is high and when their interest rate is lower the government changes the old debt to new debt.

Pros of debt redemption

  • Cost of debt management can be reduced
  • It becomes easy in future to issue debt by the government
  • Avoidance of Bankruptcy
  • On the settlement of the public debt the resources can be transferred towards private investment.
  • When the debt is paid at the earliest stage it reduces the burden of tax
  • It will hinder useless expenditure of the Government.
  • It will increase the fate of debtors in the Government.

Legal Framework in India

Article 292[1] of the Constitution of India lays down for the management of public debt in India, which authorizes the Central government to borrow the securities of the Consolidated Fund of India within its limits, if any, as may be fixed by the Parliament by law and in various other legislations as given below:

  • The Fiscal Responsibility and Budget Management (FRBM) Act, 2003[2]: This Act lays down the limitation on the Central governments borrowings, debt and deficits, greater lucidity and clarity in fiscal functions of the central government and also by governing a fiscal policy in a medium-term structure and of matters connected with that.
  • FRBM Rules, 2004[3]: These rules state the annual targets for lessening of fiscal and revenue deficits, annual targets for presuming contingent liabilities as guarantees and additional liabilities by the form of percentage of GDP.
  • RBI Act, 1934: Section 20[4] of this Act was required to maintain the central government public debt.
  • Public Debt Act, 1944: Public Debt Act is an Act to integrate the law associated with the government, securities and the maintenance of public debt by the reserved bank of India.[5]
  • Government Securities Act 2006[6]: The Government Securities Act 2006 amends the law in relation to the government securities and its maintenance by RBI and matters covered with that.

Comparison of Budget Deficit, Public Debt, and Economic Growth

Public debts have an influence on economic growth, inflation, interest rate, investments and budget deficit. A huge rise in public debt due to the unsustainable public policy would induce Seigniorage financing which affects the inflation in the economy. The income and the wealth effect of increasing public debt would lead to rise in inflation and aggregate demand in the economy.

According to Keynes, the budget deficit has a significant effect on aggregate demand which would generate employment and income when the deficit is financed by borrowing.

According to Domar, if the growth in income is at the constant percentage rate, then the growth of debt will approach the growth of income, therefore the rate of debt to GDP will become stationary. Over the period of time escalating debt burden on the government has been seen as a serious implication for the fiscal imbalance of the state. An empirical estimation of the long run relationship between debt and deficit would be an immense significance to discover the sustainability of fiscal policy adopted by the government which would be an indicator for efficiency of public finance.

Present Scenario

For the financial year 2021, India’s public debt as a percentage of GDP increased to 60.5%[7] mainly on the account of ongoing Covid-19 pandemic. In May 2021, the current Government announced that it would increase its borrowing for the financial year 2021 by more than 50% to Rs.12 Lakh crore from 7.8 crore as budgeted earlier.

External debt means the money that the country borrows from institutions such as foreign commercial banks and international financial institutions such as International Monetary Fund (IMF), World Bank, Asian Development Bank (ADB). these borrowings need to be repaid in currency. According to RBI’s data India’s external debt was placed at $570 billion with an increase of $11.5 billion at the end March 2020. MoS Choudary stated in the parliament that Rs.34,715 crores have been repaid by India towards external debt in the financial year 2020-21.

Internal debt comprises loans raised in the open market borrowings through treasury bills, commercial banks and other bonds. The internal debt of the country is Rs.95,83,366 crores which is about 19.5% higher than the previous year. The total debt comprises external as well as internal debts and also accounts for other liabilities. India has witnessed a massive surge owing to the center’s increased borrowings to deal with expenditure that occurred during Covid-19 pandemic.

Further details on RBI’s Monetary Policy in the Light of Pandemic

Conclusion

This emphasizes the effects of the budget structure on the rise in debt burden of the government by dissolving total government expenditure in revenue and capital accounts. To discover the shape of the debt-deficit relationship we had seen that the state’s economic growth is more responsive to government spending on capital formation than to spending on public consumption. The more the growth rate is delicate to capital expenditures, the lower the burden in terms of net interest payment. Thus, the more the proportion of public debt toward capital expenditure, the more the growth rate is the debt will be tenable.

Edited by: Tanvi Mahajan, Publisher, Law Insider

References

Central Government Borrowings

Indian Economy by V.K. Puri and S.K. Misra

Indian Economy by Ramesh Singh

Indian Economy by Nitin Singhania

  1. The Constitution of India, Article 292
  2. The Fiscal Responsibility and Budget Management Act, 2003 ( Act 39 of 2003)
  3. The Fiscal Responsibility and Budget Management Rules, 2004
  4. RBI Act, 1934 (Act 2 of 1934), Section 20
  5. The Public Debt Act, 1944 (Act 18 of 1944)
  6. The Government Securities Act, 2006 (Act 38 of 2006)
  7. India’s Debt burden