Shift from Fiscal Deficit to Debt-to-GDP Ratio

The Union Government has announced a transition from fiscal deficit to Debt-to-GDP ratio as the primary fiscal anchor starting from FY 2026-27 with an aim to reduce the Debt-to-GDP ratio to 50±1% by 2031.

About Debt-to-GDP Ratio

• Definition: Measures the total accumulated debt of a country, including past and present borrowings, relative to its Gross Domestic Product (GDP).
• In numerical terms, the debt-to-GDP ratio is expressed as a percentage, to illustrate the number of years it would require to repay debt if GDP is dedicated solely to debt servicing
• Indicates:
  • The level of debt compared to the size of the economy.
  • A country’s ability to repay its debt based on economic performance.

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• Formula: 

• Debt-to-GDP Ratio Trends in Global Economies:
  • The global debt-to-GDP ratio in 2023 showed varied trends across economies
  • Advanced economies (AEs) excluding the U.S. saw a 9 percentage point decline to 268% of GDP, driven by reductions in private and public debt.
    • The U.S. contributed to the global reduction, with private debt falling to 150% of GDP, though public debt rose to 123%.
  • Emerging markets (EMs) excluding China experienced a 3 percentage point increase to 126% of GDP, driven by rising public debt.
    • China’s total debt surged to 289% of GDP, with both public and private debt rising significantly. 
  • Low-income developing countries (LIDCs) also saw debt increase to 88% of GDP, primarily due to higher public debt, despite falling private debt.
• Interpretation:
  • High Debt-to-GDP Ratio: Indicates high borrowings, raising concerns about repayment capacity.
  • Low Debt-to-GDP Ratio: Suggests better fiscal health with manageable debt levels.

Debt-GDP Reduction Target

• To achieve the debt-GDP reduction target, the government has outlined three scenarios based on different nominal GDP growth rates:

• This approach allows flexibility in choosing mild, moderate, or aggressive fiscal consolidation, balancing growth needs with debt sustainability.

Significance of maintaining Low Debt-to- GDP ratio: 

• A prudent debt-to-GDP ratio is essential for maintaining investor confidence and ensuring economic resilience.
• Low Debt-to GDP Ratio is necessary to create space for growth-enhancing expenditures, which is critical to achieve the growth ambitions in the broader economy.

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Rationale for the Shift to Debt-to-GDP Ratio

• Long-Term Financial Sustainability: Assesses the nation’s ability to manage debt over time.
• More Reliable Fiscal Measure: Captures the cumulative impact of past and present fiscal policies, unlike the annual fiscal deficit, which only measures short-term performance.
• Global Best Practices: Aligns with international fiscal standards, promoting greater flexibility in economic management.
• Enhances Transparency: It encourages shift from rigid annual fiscal targets towards more transparent and operationally flexible fiscal standards.
  • Ensures proper disclosure of off-budget borrowings, reducing hidden liabilities.

Limitations of Debt-to-GDP Ratio

• Ignore Debt Composition: Does not differentiate between internal (domestic) debt and external (foreign) debt.
• Does Not Reflect Fiscal Policy Efficiency: Fails to capture whether government spending is productive or wasteful.
• No Direct Correlation with Default Risk: Some high-debt countries remain solvent due to strong economic fundamentals.

About Fiscal Deficit

• Definition: The difference between total government expenditure and total revenue (excluding borrowings) within a financial year.
• Indicates: The amount of borrowing required to meet government spending needs.
• Formula: 

• Interpretation:
  • High Fiscal Deficit: Suggests the government is spending more than its earnings, leading to increased borrowing.
  • Low Fiscal Deficit: Indicates better financial management, reducing reliance on debt.
• Need of Controlling Fiscal Deficit: 
  • Impact on Inflation: A persistently high fiscal deficit can lead to inflation as the government may resort to printing more money to fund expenditures.
  • Improves Credit Ratings: Lower fiscal deficit demonstrates fiscal discipline, improving India’s credit ratings and reducing borrowing costs.
  • Better Public Debt Management: A lower fiscal deficit helps the government secure cheaper credit in international markets and attract investors.

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Conclusion

• The shift from fiscal deficit to Debt-to-GDP ratio as the primary fiscal anchor reflects India’s commitment to fiscal sustainability and transparency.
• By adopting a structured debt-reduction strategy, the government aims to enhance financial stability, improve creditworthiness, and create fiscal space for growth-oriented investments, ensuring long-term economic resilience and responsible debt management.

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