Debunking debt myths

Since Telangana’s debt of Rs 1.14 lakh cr is smaller than its budget outlay of Rs 1.49 lakh cr, the outcry has no merit.

By Author Sujai Karampuri   |   Published: 20th Mar 2017   1:23 am

Economists generally believe that debt is not always bad. In fact, it is good if the State’s economic growth can sustain and service it, which in turn depends on the size of the GDP and its growth rate, among other factors.

Most vibrant economies in the world have been built on debt. It is considered a healthy sign for a growing economy or an expanding business to take loans to fuel its growth, especially when the infusion of capital is an investment for creating the essential ingredients that will continue to sustain that growth.

Growing companies spend more money each year to create capacity for future – they build newer factories, invest in research and development, and improve skills of its employees. Similarly, growing economies take loans to fund its infrastructure projects – building roads, railway lines, power plants and canals. They also invest in welfare schemes to create a healthier and more literate population for a vibrant workforce and an enterprising population. After World War II, the US and Japan became industrial and financial giants by taking big loans to fuel their economic engines.

There are also contrarian examples of companies and countries going bankrupt because of their inability to pay off their debts.

Debt Dilemma
This brings us to an essential question – is debt good or bad? Should a country or State take massive loans whereby it mortgages its future into servicing the debts, or should it shun all kinds of debts only to lose out on the potential growth?

The answer is somewhere in the middle. A study of economies that have gone through similar growth trajectories can be a guiding factor. The United States, Japan and China have taken loans during their rapid expansion phases. The US took loans amounting to 110% of its GDP after World War II, and so did Japan. Unofficial estimates of China’s current debt is around 230% of its GDP.

Debt is good if the State’s economic growth can sustain and service it, which in turn depends on the size of the GDP and its growth rate, among other factors. If the growth rate is high and shows the same promise in the future years, then its ability to service a debt is secure.

The debt-to-GDP ratio of the three largest economies in the world – US, China and Japan – is 104%, 240%, and 230%, respectively. India is now the 7th largest economy in the world and has a debt-to-GDP ratio of only 69%. India is growing rapidly — 7% this year, and 7.6% and 7.2% in the previous years. The US and Japan have reached stagnation growing at 2% and 1.6%, while China is slowing down to 6.5%.

Attitude Towards Loans
India is a prime candidate for taking larger debts because of its size and growth rate. And yet, you will see a large outcry whenever the Indian government takes loans. That’s because Indians are squeamish when it comes to debts and they see loans as bad. The same attitude has permeated into our polity and media who decry any debt of the government.

So, when Telangana presented its Budget recently with a growing debt, the media predicted a doomsday scenario, calling it a “big financial crisis” and that “coffers are bleeding on debt”. They accuse the State of “pushing people into a huge debt trap”. Looking at these news headlines, a common reader assumes that there is something grossly wrong with the increasing amount of loans taken by Telangana.

Objective Analysis
Only an objective analysis can reveal the truth behind these worrisome fears.

Telangana is now one of the fastest growing States in India with a GSDP growth rate at 10.1%, much higher than the country’s average of 7%. Its GSDP at Rs 6.54 lakh crore makes it the 11th largest in the country, bigger than Haryana or Punjab, and bigger than countries like Sri Lanka or Ukraine.

Currently, Telangana is investing in urban development, building roads, and in projects like Mission Kakatiya that aims to restore nearly 46,000 tanks. It plans to nearly quadruple its power generation capacity. Under Mission Bhagiratha, it plans to give tap water connection to the entire rural population, while connecting every home with fibre optic connectivity. These investments into infrastructure along with welfare schemes in healthcare and primary education have far reaching consequences for any economy.

Irrational Fears
When compared with other States in India, Telangana’s debt-to-GSDP Ratio is only 17.4% while nearly 15 States in India have larger debt ratios.

Leading the pack is West Bengal at 32.9% followed by Rajasthan at 31.4% and Uttar Pradesh at 30.1%. Even the so-called progressive States such as Gujarat, Tamil Nadu and Maharashtra have higher debt-to-GSDP ratios compared with Telangana which has a ratio less than the country’s average of 21.2%.

Some critics warn that Telangana’s debt is quite high as against its budget outlay. A progressive State like Gujarat has a debt of Rs 1.65 lakh crore against a Budget outlay of 1.51 lakh crore – more debt than its budget outlay. Maharashtra, Andhra Pradesh, Tamil Nadu and Karnataka have bigger debts than their budget outlays. Whereas Telangana’s debt of Rs 1.14 lakh crore is smaller than its budget outlay of Rs 1.49 lakh crore. So definitely, this outcry against Telangana has no merit.

Both from fiscal and development angles, it is evident that Telangana can and needs to take more loans to fund its growth story. The Central Government should support such growing States by increasing their borrowing capacity.