Sometimes, you just have to hand it to government officials. They can take their most terrible failures and present them as a success. Latest case in point, the budget deficit. Arun Jaitley calls it “fiscal prudence” to have a fiscal deficit of 3.2% of GDP, which will almost surely be revised upwards, since that is just an estimate.
But fiscal deficit does not tell the whole story. Reading the budget documents, one comes across a number called the primary deficit. That is the fiscal deficit minus the interest payments on loans that government has taken over the years. The primary deficit is just 0.1% of the GDP. Meaning that most of the fiscal deficit is there to pay back previous loans.
Just so it sinks in, I shall say it again. The government is taking new loans to pay back the interest on its old loans. In fact, 18% of the central government’s budget goes to these interest payments. Does that sound prudent? Because from where I am sitting, that is very, very irresponsible.
And I have not even spoken about the principal amount of the loans. The central government owes a debt of around 65% of the GDP. A debt which grows at an astounding rate of ₹1.32 lakh per second.
Borrowing to repay old loans is very similar to a Ponzi scheme. In fact, if any of us did that, we would be in jail right now, but when politicians do it, it magically becomes “fiscal prudence”.
“But why”, you might ask, “is this a problem?” Let us look at the some other countries that have gone down this path. Japan, which had gone down this path some time ago, lost two decades after that, during which the economy stagnated. Japan’s economy continues to be sluggish. Also, the Japanese pay more than 40% of their tax revenues for interest payments on old debt.
Or look at Greece which is stuck in an even worse debt crisis. The Greek debt to GDP ratio is 180%. The overall tax burden on the Greek economy, to service this enormous debt, is 34% of GDP (double of India’s 17%). This has led to massive unemployment (at 26.5%) and great political instability in Greece.
Why hasn’t it happened in India yet?
One thing any careful observer will notice about Greece and Japan is that they have relatively older populations. This is why their economic growth is considerably lower. India, on the other hand, has the world’s largest youth population, which will grow for the next few years. This demographic dividend is giving us higher economic growth and a larger tax base. This allows the government to service the debt, for now.
But, within a few decades, India will have the world’s largest aged population. As the tax base shrinks and more welfare benefits have to be paid out by the government, India will find itself in a similar debt crisis. In other words, the Ponzi scheme of New Delhi will collapse when there are fewer new subscribers.
The burden of that debt crisis, by the way, will fall on generations yet unborn. It would be morally reprehensible for us to saddle them with such huge levels of debt so that we can enjoy life today.
How do we curb debt accumulation?
The debt owed by the central government has been accumulated over almost 70 years. It will not be easy to get rid of it. It is not impossible, however. I shall explain the necessary steps to eliminate the debt and put India on the path of healthy growth.
First, eliminate the deficit. Having a budget surplus will allow repayments of the principal amounts and get rid of the debt in the next two or three decades. How do we create a surplus? One way would be to increase tax rates, but that is undesirable for economic growth, and will be politically damaging for any government. Therefore, the alternative that remains is to cut down government spending. In a developing country such as India, total government spending should not exceed 10% of the GDP, as recommended by the great economist Milton Friedman. When America was at this stage of development, the federal government did not spend more than 3% of its GDP. In India, however, the central government alone spends more than 10% of GDP. This slows down economic growth by taking resources away from a more efficient private sector.
However, tax revenues still need to rise. How do we increase tax revenue while keeping tax rates constant? The answer is to boost economic growth. What is the best way to increase economic growth? It turns out that when there are too many regulations and restrictions on economic activities, growth is slower. On the Index of Economic Freedom, India ranks an abysmal 123, behind countries such as Sri Lanka, Uganda and even Nigeria.
The sheer number of regulations in this country prevents the economy from achieving its full potential. The government needs to take serious measures to improve economic freedom in India. Doing so would unleash the productive energies of the world’s largest youth population, leading to higher incomes for people. This would translate into higher tax revenues without increasing tax rates.
Some of the measures I suggested will be difficult to implement, but, there are only two options. Either those measures are implemented, and India goes on to become a healthy economy similar to Hong Kong and Singapore, or they are not implemented and India goes the way of Japan and Greece.