News of the US federal government debt growing to $36 trillion has been making waves of late. The number has managed to shock financial markets out of the Trump-induced euphoria, taking stocks and currencies lower. This, along with the news that global public debt is set to hit $100 trillion in 2024, helps underline the urgency needed to bring the debt levels lower.

The negative consequences of high debt are many including higher borrowing costs in the economy, instability in currency markets caused by capital outflows, higher inflation expectations. With soaring interest burden and repayment obligations, government spending on other areas can reduce eventually impacting growth.

Most countries had significantly increased public debt since 2020 as central banks opened the liquidity spigots to stave off recession. Global debt-to-GDP ratio has increased to 93.2 per cent in 2024, up from 83.9 per cent in 2019. India too has been adding to its debt stock with spending by both the Centre as well as the States surging since the pandemic.

It’s well that the Centre is now shifting its focus towards debt reduction with the Finance Minister promising to bring the debt-to-GDP ratio down over the coming years. But this can be achieved only if a clear action plan is drawn up and rigorously implemented to tackle the debt by both the Centre as well as the State governments.

India’s debt pile

Outstanding debt of the Central government stood at ₹86 lakh crore in March 2020. The additional spending on healthcare and welfare measures during Covid more than doubled this number to ₹173 lakh crore by March 2024. Though the fiscal deficit has been reined at 4.9 per cent of GDP for 2024-25, the outstanding debt is expected to increase to ₹181.6 lakh crore by the end of March 2025.

The Central government debt, however, accounts for only 67 per cent of the total public debt in India. The debt taken by State governments accounts for the remaining 33 per cent. Outstanding liabilities of State governments towards the end of FY24, according to their Budgets, were ₹82.2 lakh crore. Given the political pressure to provide instant gratification to the electorate during assembly elections, checking the debt levels of States is going to be more difficult.

The combined debt-to-GDP ratio of India stands at 83.1 per cent in 2024; it was hovering around 69 per cent until 2018.

This ratio is not comforting because the average debt-to-GDP ratio for emerging market and middle-income economies stands at 70 per cent in 2024. The average for the world has been skewed by the fiscal profligacy of the G7 countries such as the US (debt-to-GDP ratio of 121 per cent in 2024), Japan (251 per cent), France (112 per cent), UK (101.8 per cent).

But it will be wrong to take solace by comparing our debt-to-GDP ratio with that of the advanced G7 countries because most of them own reserve currencies. They can simply print more currency to repay the debt, and it will be absorbed. India does not have that comfort.

The problem posed to global financial stability, as pointed by IMF in its fiscal monitor, is that the US and China, which hold large chunks of global debt are going to continue growing their debt until 2029.

India faces the additional problem of growing debt among States. According to the RBI, 19 States/Union Territories had a debt-to-GDP ratio above 30 per cent towards the end of FY24. This is much above the Finance Commission’s threshold of 25 per cent for States/UTs.

Some of the larger States such as Punjab, West Bengal and Bihar have ratios much above 38 per cent, implying that they are living far above their means.

There is also the additional problem of a large portion of debt of States being disguised as guarantees and remaining undisclosed.

Problems in tackling debt

The impact of letting debt remain at elevated levels in India is already being felt on bond yields, foreign capital outflows and currency.

The inclusion of Indian bonds in global bond indices has helped bring in some portfolio inflows into India bonds since last year. But if those flows were excluded, foreign investors have been exiting Indian debt instruments since 2020.

While the government has stated its intention to bring down debt, it needs to be followed by an action plan. According to IMF, most countries are not doing enough to tackle the problem of growing debt. It notes that, “cumulative fiscal adjustment of 3.0-4.5 per cent of GDP, on average, is needed to stabilise or reduce debt with high probability.”

Bringing down debt will not be easy given that India’s revenue as percentage of GDP, at 21.1 per cent, is much below the average for emerging economies and middle-income countries, of 27 per cent. Concerted effort is needed to increase revenue and bring down expenditure at both Centre and State level. Some tough choices may have to be made.

The revenue needs to increase through increase in tax base by getting the richer farmers and small businesses into the tax net. Exploring avenues of non-tax revenue such as sale of unused land and property of PSUs, expediting strategic sales of CPSEs and increasing the charges for public utilities, is the way forward.

State governments should increase their own tax revenues by reducing the subsidies on utilities such as power and public transport, charging for other services provided by the governments at market rates, and improving the collection of property taxes.

On the expenditure side, the wage bills need to be tackled. Hiring employees on contract could help cut future pension payouts. Automating many of government services with greater adoption of digitisation could also help cut the wage bill. Stopping the subsidies on fertilizers and food and giving coupons to the needy can also be considered.

The trouble is that growing interest cost and repayment obligations can begin to impact capex going forward, which in turn can hurt growth. But short term pain has to be borne, for long term financial stability.