How much Government Debt is the correct Debt?

As per the Economic survey and other studies, if Debt's interest rate is less than the Country's growth rate (measured by GDP), Debt is sustainable. Currently, the interest rate on sovereign Bonds on average is about 5%. If we calculate future interest rates from the yield curve, it is still less than 6%. Assuming worst-case scenario, if the interest rate increased to about 8%, then required GDP growth in real terms needs to greater than 3% (assuming the average inflation rate to be 3%), which does not seem to be an issue of much concern.

But the question that arises is how much Debt should Country take? The Country's current Debt to GDP ratio is 68%, which amounts to 1.9 trillion USD. Assuming an interest rate of about 5% on average, this amounts to an interest payment of 95 Billion USD. India's 2020 budget was 410 Billion USD (Rs 30 lakh Crores). Hence about 25% of the budget is spent on the interest payment. The study says that if Govt spends this loan which translates into higher GDP than the interest rate and hence higher Revenue receipt through taxation, the Government won't have to worry about Debt.

To repay this Debt, Government needs to borrow both principal and interest amounts from the Market. Assuming Government can roll-out its current Debt at the same rate or the rate less than the Country's growth rate, an increase in the Country's GDP will be higher than the interest payment on Debt. But the condition required here is that this increase in GDP should also lead to an increase in Revenue Receipts for Government.  As in longer terms, though Debt will rise in value, Debt/ GDP will decrease

But this still doesn't answer the question that how much Debt is the right Debt. Let's measure the current amount of Debt. Let's say that GDP is 10% in nominal terms, then GDP will increase by 300 Billion USD. (Revenue Receipts)/ GDP ratio is about 10%; hence, this will increase revenue receipts by 30 Billion USD. But the current interest payment is 95 Billion USD. Therefore Government needs to take another 65 Billion USD to fund its interest payment. Since the GDP has also increased at a consistent Debt/ GDP ratio of 65%, the Government can take about 195 Billion USD and fund this interest payment.

I calculated the amount of loan the Government can take if it wants to retain a Debt level sustainable in the year 2021.  Given that GDP is expected to decrease in 2021, to keep the debt level sustainable, it can plan to take a Debt of 120 Bn USD (i.e., about 10% of the 2021 GDP level). The debt/GDP ratio will worsen in the current year, but it will get back to normal by 2023. If the Government plans to take a 280 USD loan, the current DEBT/GDP ratio will worsen to 82%, but it will come back to the current level by the year 2025, assuming a forecasted GDP growth rate.

	2020	inc/dec	2021	inc/dec	2022	inc/dec	2023
India's GDP	2800	-8%	2576	14%	2936.64	7%	3142.205
Debt/ GDP	65%		75%		68%		66%
Government Debt	1820	119.37	1939.4	64.11	2003.5	83.81	2087.3
Interest Rate	5%		5%		5%		5%
Interest Payment	91		96.97		100.2		104.4
Revenue Receipts	280		257.6		293.7		314.2
Increase in Revenue Receipts			-22.4		36.1		20.6
Net Balance			0.00		0.0		0.0

	2020	inc/dec	2021	inc/dec	2022	inc/dec	2023	inc/dec	2024	inc/dec	2025
India's GDP	2800	-8%	2576	14%	2936	7%	3142.20	8%	3393.58	8%	3665.06
Debt/ GDP	65%		82%		74%		72%		69%		67%
Government Debt	1820	280.00	2100	72.56	2172.6	92.71	2265.3	92.76	2358.0	95.53	2453.6
Interest Rate	5%		5%		5%		5%		5%		5%
Interest Payment	91		105.0		108.6		113.3		117.9		122.7
Revenue Receipts	280		257.6		293.7		314.2		339.4		366.5
Inc in Revenue			-22.4		36.1		20.6		25.1		27.1
Net Balance			152.6		0.0		0.0		0.0		0.0

Though some assumptions were made in these calculations, which need to be looked into. One that Government investment will not impact private investments (Private Companies and Households). In emerging and growing economies like India, where unemployment levels are high and diverse opportunities exist, this will not lead to the private sector's crowding-out impact. Also, high debt financing by the Government could decrease the amount available for private investments and hence increase in interest rate.

If an increase in private savings does not accompany higher public Debt (i.e., lower public savings), it may also lead to lower total savings in the economy. This may put upward pressure on the interest rates, resulting in crowding out of investment and thus negatively impacting the growth rates. But this investment is also leading to an increase in private savings, and there is less probability of this to occur.

Regarding Foreign Debt, Government's debt portfolio is characterized by very low foreign exchange risk as the external Debt is only 2.7 percent of GDP ( 5.9 percent of total Central Government liabilities) (Figure 20). Of the total public Debt, 70 percent is held by the Centre (Figure 19). As the central Government is entrusted with macro-economic management's responsibility, this distribution of Debt between the center and states is desirable because of the incentive compatibility that it generates. The long maturity profile of India's Public Debt (issuance of longer tenure bonds), along with a small share of floating rate debt (floating rate debt of Central Government is less than 5 percent of public Debt), tends to limit rollover risks and insulates the debt portfolio from the interest rate volatility.

Raising the debt level by 15-20% of GDP should not be much of concern, but India needs to focus on its GDP growth and ensure that it's higher than the inflation rate at the aggregate level.