The fiscal situation is such that the revenue receipts would fall short of debt servicing-let alone meet current and developmental expenditure." This is not a soundbite from an economist or a critic from a rating agency. This is what the BJP National Executive said in its economic resolution passed at Goa's Marriott Hotel in April this year. So what the international rating agency Standard & Poor's (S&P) stated last week was nothing startling. The resolution admitted that the Government is borrowing more than it earns and this is to pay past debts.

It is a succinct articulation of India's fiscal condition. To appreciate the concern consider these numbers: this year the Union Government expects to earn Rs 2,45,105 crore as revenue while its debt servicing commitment (interest and repayments) is Rs 2,58,005 crore. The deterioration has not happened overnight. Gross fiscal deficit (the difference between the government's income and spending) has doubled from Rs 60,257 crore in 1993-94 to Rs 1,35,524 crore this year. What's more the Government has consistently borrowed more than it has budgeted for every year since 1991-92.

SOARING SPIRAL Rising internal debt requires higher economic growth to sustain it

It isn't just the Centre. State governments too have been borrowing to spend. Deficit of state governments has tripled from Rs 27,696 crore in 1994 to Rs 95,622 crore in 2001-2. Worse, states have over the past six years resorted to creation of special-purpose vehicles to borrow outside the budget. Since 1995, state enterprises have raised Rs 55,200 crore through public issues of tax-free bonds guaranteed by state governments. It is feared (according to an internal note of the Finance Ministry and a Crisil study ) that issues worth Rs 44,500 crore will devolve on state governments adding to their debt.

Such populist profligacy in the past 10 years has caused the debt of state governments to shoot up nearly five times since 1993-94 to Rs 5,87,780 crore this year and that of the Centre from Rs 2,45,712 crore to Rs 10,21,739. Thwarted by their own borrowing levels governments at the Centre and states added to the burden by issuing guarantees worth Rs 2,55,574 crore. But naturally, internal debt has tripled from Rs 5,06,343 crore in 1993-94 to Rs 17,52,406 crore in 2001-2 or Rs 17,524 per Indian. To get a perspective, compare this with India's income last year: Rs 23,10,894 crore. The Centre's domestic debt is well over 75 per cent of the GDP. If local liabilities of the Government are included, it would touch 86 per cent of the GDP.

Even as the system battled with this bulge, the fiscal showed further signs of fragility. The storm over privatisation threatening the Rs 12,000 crore budget target and the massive bailouts for UTI, IDBI and IFCI could now push this year's deficit to more than the projected Rs 1,35,524 crore. The resultant increase in borrowings would aggravate the debt levels. In fact, in September an International Monetary Fund (IMF) report stated that India's debt to GDP ratio is high by international standards and that the actual debt to GDP ratio is higher than that of crisis-hit countries like Brazil, Argentina and Turkey.

"The concerns highlighted by S&P—the level of rupee debt and the pace of reforms—are genuine." Roopa Kudva, Executive Director & Chief Rating Officer, Crisil

"The debt level is worrying and we are taking steps. But the S&P downgrade is not justified." Jagdish Shettigar, Member, PM's Economic Advisory Council

It is precisely these concerns that prompted S&P to lower local currency sovereign credit ratings. S&P Managing Director John Chambers has cited the Union Government's growing rupee-debt burden, its inability to staunch the financial weakening of the public sector and containing the budget deficit at 6 per cent of the GDP as the causes. He fears the debt of the Union and state governments could exceed 80 per cent of the GDP this year. Implicit is the concern that rising debt crowds out investment in infrastructure.

While the Finance Ministry didn't quite agree with the S&P view (see box), the political establishment was outraged. Says Jagdish Shettigar, member of the BJP's National Executive and member of the Prime Minister's Economic Advisory Council: "The very credibility of the rating agency is under question. The debt level is a worrying situation and we are taking steps. But the downgrade is not justified." Shettigar feels the timing of the downgrade and observations on reforms are motivated.

Roopa Kudva, executive director and chief rating officer at Crisil, disagrees. An integral part of sovereign analysis is economic management and reforms are key to economic management as they can have a critical impact on reducing pressure on government finances. "Nobody is saying insolvency of the government is an immediate issue. But the concerns highlighted by S&P-the level of rupee debt and the pace of reforms-are genuine."

Perhaps. But the question being debated is how much is too much? Some economists argue that if Japan with a debt-GDP ratio of 150 and Italy with over 115 have managed to survive why can't India? However, both have mature capital markets and Japan has an inflation rate of less than 1 per cent that sustains such high debt ratios. Says New York-based Shelly Shetty, director, Ratings, Fitch: "There is no magic number on the domestic debt-to-GDP that is unsustainable. However, for an emerging market like India, general government deficits of 9-10 per cent of GDP are clearly unsustainable in the medium term." Indeed, Anne Krueger, deputy managing director of the IMF, believes, "Fiscal deficits of 10 per cent or more are not sustainable. Something will have to give and trigger a crisis."

The saving grace for India is that unlike crisis economies its internal debt is largely in rupees and its external debt-GDP ratio relatively low. Also, given the average 5 per cent-plus growth the system is awash with liquidity. Indeed, banks have invested over 40 per cent of their funds in government securities when the obligatory requirement (under statutory liquidity ratio norms) is 25 per cent. There is hardly any demand for credit and thus no crowding out of private investment.

REASONS FOR DISSENT: The Finance Ministry ridicules the downgrade

« India is among the fastest growing economies at 5.85 per cent over 10 years. « India's forex reserves at $62 billion is among the highest in the world. « Inflation has been below 4 per cent for well over 18 months. « Interest rates have dropped from 10-plus per cent and the sovereign 10-year paper is now at just 7 per cent. « The Fiscal Responsibility Bill has been cleared by the Standing Committee and will be introduced in Parliament. « A special cell has been set up to suggest measures to improve tax-GDP ratio. « The Centre has also mooted a programme to enable states to swap expensive debts.

Finance Minister Jaswant Singh

The catch here is that this could be at best transitory. Lack of investment has already pushed down growth and the tax-GDP ratio (now less than 10). Low GDP growth would worsen the income-expenditure gap as revenue growth dries up and the government borrows more. Growth requires investment. If and when investment does pick up the Government's burgeoning appetite could either crowd out private borrowers or push up interest rates making investment unviable. The Government needs to snap out of this fix.

It isn't that the economy managers are unaware of the magnitude of the imbalance and its implications. The problem is historical. High level of debt, for instance, is a legacy of Nehruvian economics. In the past decade, tax cuts have improved revenues and reduced GDP-deficit ratios in the mid-1990s, but the blind acceptance of the Fifth Pay Commission recommendations negated the gains. The industrial slowdown led fall in revenues aggravated the income-expenditure gap.

The answer clearly lies in cutting expenditure and legislating fiscal responsibility. The Centre also needs to fine tune FDI to boost inflows and boost revenues via privatisation.

That again is not something that S&P said but what the BJP believed in.