INCREASE IN NATIONAL DEBT, DECREASING GDP

AUTHOR- PAVITRA POTTALA

COLLEGE / UNIVERSITY NAME – MAHARASHTRA NATIONAL LAW UNIVERSITY AURANGABAD

COURSE – B.A.LL.B(HONS.)

ABSTRACT

This research examines the “Impact of National Debt, Decreasing Gross Domestic Product (GDP).” Debt is such an important aspect of economic growth that it has to be calculated properly in order to convey its long-term effects on nation’s economy.

The effect of national debt on GDP growth is examined, and it is concluded that national debt seems to have a negative effect on economic growth if it is for long term. The effect of national debt on economic development has remained a contentious issue in economics, and the debt level continues to rise. “The government’s heavy reliance on debt could stifle investment and economic development.

throws light on the impact of increase in national debt on decreasing GDP in terms of factors that emerges from the National debt which affecting the GDP. In addition to this, it also aims to critically analyse regarding the same and puts some suggestions or recommendations for betterment of economy in future.

Key words – national debt, GDP, Economy, Government and India.

INTRODUCTION

National debt refers to the total of all debts owed by the government of a country. It mostly comes from bonds and other debt securities, but can also be from direct borrowing from international organisations such as the World Bank. “The national debt is the public and intra-governmental debt owed by the federal government.”[1] It is also called as sovereign debt, public debt, country debt, or government debt.

“The final monetary value of all goods and services generated within a specified period, usually a year, is the gross domestic product (GDP). GDP is the calculation of the economic output of the country in a year.”[2]

The effect of national debt on GDP growth is examined, and it is concluded that national debt seems to have a negative effect on economic growth if it is for long term. The effect of national debt on economic development has remained a contentious issue in economics, and the debt level continues to rise. “The government’s heavy reliance on debt could stifle investment and economic development.”[3]

RELATION OF NATIONAL DEBT AND GDP

Whenever, the “federal government” spends more money than it earns from revenue-generating operations like taxation, it creates a “budget deficit”[4]. The Treasury Department would print treasury bills, treasury notes, and treasury bonds to cover up the difference in order to function in this manner. The federal government can obtain the cash it requires to offer government services by selling such forms of securities, Hence “the national debt is the output of the federal government’s yearly budget deficits getting added collectively.”

The overall market value of all final goods and services generated in a country in a given year is referred to as GDP. To approximate a country’s GDP, one must quantify the overall amount of expenditure that occurs in the economy using this definition.

Debt is such an important aspect of economic growth that it has to be calculated properly in order to convey its long-term effects on nation’s economy. Since the elements of GDP are difficult to conceptualise in a way that allows for a realistic assessment of the required amount of national debt, there is a Debt-to-GDP ratio solution that may imply the extent of national debt risk.

“The debt-to-GDP ratio is a succinct way to compare a country’s economic growth (as calculated by GDP output) to its debt ratios. In other way it can be said that, this ratio informs analysts of the amount of money a country receives per year and how it relates to the amount of money it owes. The debt is estimated as a percentage of gross domestic products (GDP).”[5]

The debt-to-GDP ratio is a reliable indicator of a country’s willingness to repay its obligations because it compares what it owes to what it produces. This ratio, that’s often expressed as a percentage, can also be translated as the amount of years required to repay debt if GDP were completely committed to debt repayment.

“Debt-to-GDP Ratio is calculated by the (Debt-to-GDP = Total Debt of a country/ Total GDP of a country) Debt-to-GDP ratio equals to Total Debt of a Country divided by total GDP of a country.”[6] When a government defaults on its debt, financial panic ensues in both domestic and foreign markets. In general, the higher a country’s debt-to-GDP ratio rises, the greater its default risks.

Thus from this above mentioned formula it is derived that Country’s debt-to GDP ratio is directly proportional to Nation’s debt and inversely proportional to Nation’s GDP, hence there are following possibilities:

  1. If Nation’s debt will increase at the same time GDP of country will decrease then debt-to-GDP ratio will increase and this will create default risk for the nation.
  2. If Nation’s debt is constant at the same time GDP will decrease then debt-to-GDP ratio will increase and this will create default risk for the nation.
  3. If Nation’s debt is constant at the same time GDP will increase then debt-to-GDP ratio will decrease and this will create better conditions in nation’s economy.
  4. If Nation’s debt will decrease at the same time GDP will increase then debt-to-GDP ratio will decrease and this will be best outcome for nation’s economy.

Hence, it is concluded that 4th possibility is the best outcome of Nation’s debt and nation’s GDP in the nation’s economy.

IMPACT OF NATIONAL DEBT ON GDP AND NATIONAL ECONOMY

Keynesian macroeconomists agree “that running a current account deficit will help the economy grow by increasing aggregate demand. After quantitative stimulus has proved unsuccessful and nominal interest rates have reached zero, most neo-Keynesians favour fiscal policy instruments including government deficit spending.”[7]

“According to Chicago and Austrian school economists, government deficits and debt”[8]:

  • Damage private spending
  • Manipulate interest rates as well as the capital system
  • Reduce exports
  • Disproportionately affect future generations by higher taxes including inflation

If the national debt per capita rises, the risk of the government defaulting on its debt service obligations rises, forcing the Treasury Department to lift the yield on newly issued Treasury securities in order to lure new buyers. Since more tax money will have to be taken out in interest on the national debt, the amount of tax revenue available to use on all governmental programmes will be reduced. When borrowing for urban improvement programmes becomes more expensive, households will face a lower standard of life as a result of this change in expenditure.

Hence, if Nation’s Debt is increasing rapidly then nation compulsorily have to pay interest of debt and in this scenario nation will pay interest from GDP (which is the total value of all goods and services produced in a nation with in period of one year) then GDP will decrease but it cannot be concluded that increasing national debt will decrease GDP.

CASE STUDY OF INDIA’S NATIONAL DEBT-GDP DURING COVID-19

“The management of public debt is a major problem that both developing and developed countries are dealing with. Throughout most of the past decades, India has struggled with a high public debt-to-GDP ratio, which is so much higher than the long-term debt-to-GDP ratio targets set by various Finance Commissions (i.e. below 60 per cent).”[9]

“The graph depicts India’s national debt in comparison to its gross domestic product (GDP) from 2016 to 2020, with forecasts through 2026. In the year 2020, India’s national debt is estimated to be about 89.56 percent of GDP.”[10]

Major sectors, contributes significant part in GDP affected by Covid-19 are the “Aviation and Tourism” and “Industrial Sector”

THE AVIATION AND TOURISM SECTOR:

  • “The Aviation Sector and Tourism each contribute about 2.4% and 9.2% of our GDP, respectively.”[11]
  • In fiscal year 2018-19, the tourism industry supported approximately 43 million People
  • the first sectors to be severely impacted by the pandemic were aviation and tourism and it is one of the causes that GDP decreased due to Covid-19.

INDUSTRIAL SECTOR:

  • “In the 2019, 1st wave of the covid-19, India like other nations in the world announced lockdown due to which industries were shut down and this lead to off the production and like any other country in India too.
  • Industries contribute major part in the GDP and in the 2nd wave many states of India announced lockdown hence in 2021 also this factor affecting GDP of India.

In terms of economic growth, the coronavirus pandemic has had such a major effect on India and “during the COVID-19 pandemic, India’s debt-to-GDP ratio rose from 74% to 90%, according to the International Monetary Fund, which is not a good sign for economy of India but expects it to decline to 80% as the country’s economy recovers.”[12]

CONCLUSION

One of the most critical public policy concerns is the national debt rating. Debt may be used to promote a country’s long-term development and stability when used properly. The national debt, on the other hand, must be assessed properly, such as by measuring the rate of interest cost paid to other federal spending or by comparing debt amounts per capita. But if Nation’s Debt is will increase then nation compulsorily have to pay interest of debt and in this scenario nation will have to pay interest from GDP, then automatically it will affect the GDP as well as nation’s economy but it cannot be concluded that increasing national debt will decrease GDP directly. Lastly I would like to conclude by stating that increase in national debt can decrease GDP but not directly.

SUGGESTIONS

After my research, my suggestions are that, India needs to lower the Debt-to-GDP ratio for better future of a country , during this current scenario of covid-19 India’s GDP has declined hence government should take welfare measures to avoid debt defaults.

Hence “Rather than raise taxes, governments often issue debt in the form of bonds to raise money.” Even there are examples throughout history where spending cuts and tax hikes together have helped lower the deficit. Bailouts and debt defaults can also help a government solve a debt problem”


[1] Kimberly Amadeo

, “The National Debt and How It Affects You”( 03 May 2021) <https://www.thebalance.com/what-is-the-national-debt-4031393> accessed 20 May 2021

[2]“Definition of ‘Gross Domestic Product”(The Economics Times) <https://economictimes.indiatimes.com/definition/gross-domestic-product> accesses 20 may 2021

[3]Asit Ranjan Mohanty and Bibhuti Ranjan Mishra, “Impact of Public Debt on Economic Growth: Evidence from Indian States” <https://www.xub.edu.in/ceft/pdf/Accepted/Impact%20of%20Public%20Debt%20on%20Economic%20Growth%20Evidence%20from%20Indian%20States.pdf> accessed 20 May 2021

[4] “Government Budget Deficits and Government Debt”(The Library of Economics and liberty) <https://www.econlib.org/library/Topics/College/governmentbudgetdeficitsdebt.html> accessed 20 May 2020

[5] Kimberly Amadeo, “What Is the Debt-to-GDP Ratio?”( 02 May 2021)<https://www.thebalance.com/debt-to-gdp-ratio-how-to-calculate-and-use-it-3305832> accessed 20 May 2021

[6] Will Kenton, “Debt-to-GDP Ratio”(04 May 2021)<https://www.investopedia.com/terms/d/debtgdpratio.asp > accessed 20 May 2021

[7] Investopedia Staff, “Keynesian Economics”(30 April 2021) <https://www.investopedia.com/terms/k/keynesianeconomics.asp> accessed 20 May 2021

[8] Investopedia Staff, “Austrian School” (06 January 2021) <https://www.investopedia.com/terms/a/austrian_school.asp> accessed 20 May 2021

[9] Ranjan Kumar Mohanty and Sidheswar Panda, “How Does Public Debt affect the Indian Macroeconomy? A Structural VAR Approach” (22 January 2019) <https://www.nipfp.org.in/media/medialibrary/2019/01/WP_250_2019.pdf> accessed 21 May 2021

[10]  Aaron O’Neill, “National debt of India in relation to gross domestic product (GDP) 2026” (May 5, 2021)

<https://www.statista.com/statistics/271319/national-debt-of-india-in-relation-to-gross-domestic-product-gdp/> accessed 21 May 2021

[11] Sayali Deshpande, “Impact of Covid-19 on Indian economy”(04 October 2020) <https://timesofindia.indiatimes.com/readersblog/midweekread/impact-of-covid-19-on-indian-economy-26770/> accessed 21 May 2021

[12]  Vitor Gaspar, “India’s debt-to-GDP rose to 90% during Covid-19 pandemic, says IMF”(09 April 2021)

< https://www.business-standard.com/article/economy-policy/india-s-debt-to-gdp-rose-to-90-during-covid-19-pandemic-says%E2%80%88imf-121040800168_1.html> accessed 22 May 2021

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