Is India Heading Towards an Internal Debt Trap?

Summary

Dr. S. R. K. Rao, former Principal Adviser to the Reserve Bank of India, delivered this lecture under the Forum of Free Enterprise auspices in Bombay on 31 August 1988. The text develops the concept of an “Internal Debt Trap” that Rao says he first publicly enunciated at the Ninth Public Sector Banks’ Economists’ Meet in New Delhi on 30 May 1986, and which subsequently attracted backing from N. A. Palkhivala, eminent Indian economists, and the international press. Rao defines the trap as the threshold beyond which fresh government borrowing is no longer sufficient even to meet the debt-servicing burden, and he argues that India is rapidly approaching that point — a possibility he and his Reserve Bank colleague A. Seshan empirically tested and pinned to roughly 1992-93 on the basis of historic growth rates of 15.3 per cent in net market borrowings and 25.7 per cent in interest payments between 1979-80 and 1986-87.

The bulk of the lecture marshals official evidence — successive “Economic Survey” reports, RBI Annual Reports, the Eighth and Ninth Finance Commission papers, the CAG’s July 1988 Report on Public Debt, and the World Bank’s recent India report — to show that the deficit on revenue account has risen sharply, that tax-to-GDP buoyancy is being outrun by non-plan expenditure (defence, subsidies, interest, transfers to States), and that total Central liabilities reached 64 per cent of GDP and Rs. 1,66,546 crores by 1986-87. Rao stresses four “supply-side” parameters that make the Indian government securities market a captive rather than inexhaustible source — the small share of household holdings, the inordinate delays in fructification of investments, the limited household-sector elasticity to interest-rate hikes, and the constraint that monetary targeting now places on the RBI’s ability to absorb residuary loan tranches. He compares the trajectory with the “sybaritic psychology” that drove Argentina, Brazil, Chile and Mexico into an external debt trap in the 1970s.

The final sections weigh policy alternatives. Rao is sceptical of cosmetic remedies: a statutory ceiling under Article 292 of the Constitution (advocated by B. K. Madan and the Public Accounts Committee) founders on the “Cinderella phrase” of exceptional circumstances; a Gramm-Rudman-style six-year zeroing of the revenue deficit, contemplated by the Ninth Finance Commission, is judged unlikely to outperform earlier Five-Year-Plan targets given Pay Commission, NDC and disaster-relief commitments. His preferred alternative is “Debt Planning” coupled with a “Disaggregation Model” — every loan tranche tagged to specific productive projects or areas, with defined minimum yields and maximum gestation lags accountable to Parliament — so that public borrowing functions as a catalyst to growth rather than a means of bridging structural revenue gaps. The Conclusions section warns that interest costs already represented 56 per cent of non-RBI borrowings in 1987-88 against 44 per cent in 1980-81, and that household savings rates have plateaued just as crowding-out is set to intensify.

Key points

• Rao defines the “Internal Debt Trap” as the threshold beyond which fresh government borrowings cannot even meet debt-servicing charges, let alone fund development.

• He locates the empirical danger zone around 1992-93 based on 15.3% annual growth in net market borrowings and 25.7% growth in interest payments between 1979-80 and 1986-87.

• Four supply-side parameters — captive securities market, delays in fructification, inelastic household savings response to interest rates, and monetary targeting — undercut the optimistic view that India can keep borrowing indefinitely.

• Rao draws an explicit parallel between India’s fiscal trajectory and the “sybaritic psychology” of Argentina, Brazil, Chile and Mexico (the “ABCM Countries”) that led them into an external debt trap.

• He marshals the Economic Survey, RBI Annual Reports, the Eighth and Ninth Finance Commissions, the CAG’s July 1988 Public Debt Report, and the World Bank’s India report as converging evidence of structural revenue-expenditure imbalance.

• Total Central liabilities rose from Rs. 59,749 crores in 1980-81 to Rs. 1,66,546 crores in 1986-87 (64% of GDP); borrowings of Rs. 27,000 crores planned for 1989-90 mean half of fresh borrowings would only service interest.

• Rao rejects statutory ceilings (Article 292) and Gramm-Rudman-style zeroing as mechanistic, and proposes “Debt Planning” plus a “Disaggregation Model” tagging each loan tranche to productive projects with parliamentary accountability.

• He credits N. A. Palkhivala with popularising the “Internal Debt Trap” concept after Rao first enunciated it on 30 May 1986, and acknowledges the Business Standard for early press coverage.