Public Debt in India - Internal vs External Debt, Debt-to-GDP Ratio, Debt Sustainability, and Recent Developments

Public Debt in India - Internal vs External Debt, Debt-to-GDP Ratio, Debt Sustainability, and Recent Developments

Opening Hook (Think Like a Household): Imagine a family that takes a home loan. If the loan helps them buy a productive asset, the future income and comfort can justify the EMI. But if the family keeps borrowing just to pay old EMIs and daily expenses, stress rises. A government's borrowing works in a similar way. Public debt can support growth when it funds infrastructure, health, and education, but it becomes risky when debt grows faster than the economy and a large part of revenue goes only into interest payments.

For UPSC, public debt is important because it is connected to fiscal deficit, interest payments, macroeconomic stability, inflation, crowding out of private investment, and the overall credibility of India's fiscal policy. It also links to the Constitution, the FRBM framework, RBI's debt management role, and India's evolving bond market.

1) Introduction to Public Debt: Why Governments Borrow

Governments borrow when their total expenditure is higher than their total receipts (excluding borrowings). Borrowing becomes the bridge between public needs and available resources. India borrows for many reasons:

• Capital expenditure: building roads, railways, ports, digital infrastructure, irrigation, defence modernisation, etc.
• Counter-cyclical support: during recessions, natural disasters, pandemics, or sharp global shocks.
• Smoothing revenues: tax collections can be volatile; borrowing supports continuity of essential services.
• Refinancing old debt: repaying maturing debt is often done by issuing new debt (rollover), especially when deficits persist.

Key UPSC idea: Borrowing is not automatically "bad". The real question is: Is the debt sustainable and is borrowing used productively? Productive borrowing increases future growth and revenue, improving repayment capacity.

2) Constitutional Provisions on Borrowing: Article 292 and Article 293

India's Constitution clearly provides borrowing powers to the Centre and States. The aim is to allow fiscal autonomy while ensuring macroeconomic stability.

2.1 Borrowing Power of the Centre (Article 292)

Article 292 empowers the Union (Government of India) to borrow upon the security of the Consolidated Fund of India, within limits fixed by Parliament.

2.2 Borrowing Power of States (Article 293)

Article 293 empowers States to borrow within India upon the security of the Consolidated Fund of the State. However, States face restrictions if they are indebted to the Centre or if the Centre has given them guarantees. In such cases, Centre's consent may be required.

Constitutional Framework of Public Debt (Table)

3) Types of Public Debt in India: Internal Debt vs External Debt

Public debt can be classified in several ways. The most common UPSC classification is internal debt versus external debt. Another important classification is short-term vs long-term, and marketable vs non-marketable.

3.1 Internal Debt: Meaning and Core Features

Internal debt refers to borrowings raised within India, usually denominated in Indian rupees. It is typically held by domestic institutions and residents. In India, internal debt forms the major share of government debt.

Why internal debt is usually considered safer:

• No foreign currency risk: repayment is in domestic currency.
• Stable investor base: banks, insurance, provident funds, RBI-regulated institutions.
• Policy flexibility: government and RBI can manage liquidity and yields through domestic tools.

3.2 External Debt (Public External Debt): Meaning and Core Features

External debt is borrowing from non-resident sources. For the government, this includes loans from multilateral and bilateral agencies and other external sources. External debt needs careful handling because it may involve foreign currency exposure, global interest rate risk, and external sector vulnerability.

Why external debt can be riskier:

• Exchange rate risk: if rupee depreciates, repayment burden rises in rupee terms.
• Global financial conditions: foreign interest rates and risk appetite can change quickly.
• External vulnerability: higher external debt can pressure the balance of payments in stress periods.

4) Components of Internal Debt in India

Internal debt is not one single instrument. It is a collection of instruments with different maturities and holders. For UPSC, know the major components and their broad meaning.

4.1 Market Loans (Dated Government Securities)

Market loans are raised by issuing dated government securities (G-Secs) with a fixed maturity (for example, 5 years, 10 years, 30 years). These are auctioned and traded in the secondary market. They are the backbone of India's market borrowing.

Common types of dated G-Secs:

• Fixed Rate Bonds: coupon is fixed.
• Floating Rate Bonds (FRBs): coupon varies with a benchmark.
• Inflation-Indexed Bonds: returns linked to inflation (conceptually important; market usage can vary over time).
• Sovereign Green Bonds: proceeds earmarked for eligible green projects (energy transition, clean transport, etc.).

4.2 Treasury Bills (T-Bills) and Other Short-Term Instruments

Treasury Bills are short-term government securities with maturities like 91 days, 182 days, and 364 days. They are issued at a discount and redeemed at face value. They help in short-term cash management and are part of internal debt.

Governments may also use other short-term cash management instruments depending on policy design and market conditions.

4.3 Small Savings and National Small Savings Fund (NSSF)

India has a strong small savings system through post offices and government-backed schemes (like savings certificates, deposits, etc.). Collections are pooled in the National Small Savings Fund (NSSF), which is then used for financing government needs as per framework rules. This is non-marketable and often considered a stable source.

4.4 Provident Funds and Other Non-Marketable Liabilities

Government liabilities can include borrowings from provident funds and similar instruments where funds are mobilised domestically. These are often captive and long-term in nature.

5) Sources of External Debt Relevant for India (Public and Overall External Debt Context)

When UPSC asks about sources of external debt, it often expects you to know broad categories. For public external debt (government-related), multilateral and bilateral sources are very important. For India's total external debt, categories like ECBs, trade credit, and NRI deposits also matter.

5.1 Multilateral Sources

• World Bank Group: includes IBRD/IDA loans in development finance context.
• IMF: typically a lender of last resort; India's normal development borrowing is not IMF-driven in recent decades, but IMF remains conceptually important for external stability discussions.
• Asian Development Bank (ADB): infrastructure, urban services, sector reforms, climate-related projects.
• Other multilaterals: depending on project and programme needs.

5.2 Bilateral Sources

Bilateral loans are provided by one country to another, often for development projects, technology cooperation, or strategic/economic partnership programmes.

5.3 External Commercial Borrowings (ECBs)

ECBs are borrowings by Indian companies (and sometimes eligible entities) from overseas lenders. For UPSC, remember: ECBs are a major part of India's total external debt, even if not always a direct government liability. However, they can create macro vulnerability during global tightening or rupee depreciation.

6) Internal vs External Debt: Comparison Table (UPSC Must-Write)

7) India's Public Debt Composition: What Does the Debt Stock Look Like?

In India, internal debt dominates the government debt structure. External debt of the government is typically a smaller share compared to domestic liabilities, though India's overall external debt (including private) can be significant.

Important UPSC nuance: "Public debt" in Indian budget and RBI context often refers to liabilities of the government. But "public sector debt" or "general government debt" can include Centre + States and sometimes broader public sector liabilities. Always clarify your base in answers.

India Debt Composition (Illustrative Table for Answer Writing)

How to use this in Mains: Add one line: "India's debt is largely domestic and rupee-denominated, reducing currency risk; however, high interest payments and rollover needs remain key fiscal challenges."

8) Debt-to-GDP Ratio: Meaning, Use, and Limitations

Debt-to-GDP ratio compares the debt stock with the annual value of goods and services produced (GDP). It is widely used as a quick indicator of debt burden.

8.1 Why Debt-to-GDP Ratio Matters

• Repayment capacity proxy: higher GDP means larger tax base and repayment capacity.
• Investor confidence: markets view debt-to-GDP as a signal of fiscal health.
• Fiscal policy anchor: many fiscal rules use debt ratios as long-term anchors.
• International comparisons: helps compare debt burden across countries.

8.2 Limitations (Very Important for UPSC Analysis)

• Does not show debt quality: debt used for productive capex differs from debt used for revenue expenditure.
• Ignores maturity profile: long maturity is safer than heavy short-term rollover.
• Ignores interest-growth dynamics: if growth is strong and interest rates are moderate, debt can be sustainable even at higher levels.
• Ignores who holds the debt: domestic stable holders reduce risk compared to volatile foreign holdings.
• Gross vs net debt confusion: net debt adjusts for government financial assets; gross debt does not.

9) FRBM Act and Targets: How India Tries to Control Debt

The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was introduced to institutionalise fiscal discipline, improve transparency, and reduce fiscal risks. It aimed to reduce deficits and manage debt in a rule-based manner.

9.1 Core FRBM Logic

• Control fiscal deficit so that borrowing does not explode.
• Reduce revenue deficit so that borrowing is used more for capital creation rather than day-to-day consumption.
• Improve transparency through fiscal indicators and reporting.

9.2 FRBM Targets (Conceptual Clarity for Answers)

India's FRBM framework has evolved over time, but UPSC expects you to remember these broad anchors:

• Fiscal deficit target: often discussed around 3% of GDP as a medium-term benchmark (with deviations allowed under specified conditions).
• Debt anchor concept: an overall cap/target for government debt as a share of GDP (commonly expressed for general government and separately for Centre/States in policy discourse).
• Escape clause: allows temporary deviation in exceptional circumstances (economic shock, calamity, etc.).

Best UPSC framing (balanced): "FRBM is necessary for credibility and macro stability, but rigid targets can be pro-cyclical. India needs a flexible, credible medium-term fiscal framework that protects capex and prioritises debt sustainability."

10) Ways and Means Advances (WMA): Short-Term Borrowing from RBI

Ways and Means Advances (WMA) are temporary advances given by the RBI to the government to meet short-term cash mismatches. They are not meant to finance long-term deficits. WMA helps avoid disruptions in government payments when tax inflows are uneven across months.

10.1 Types of WMA (Broad Idea)

• Normal WMA: within a limit decided as per agreed framework.
• Overdraft: if government exceeds WMA limits, it may enter overdraft with stricter terms (used only for short periods).

10.2 UPSC Angle: Why WMA Matters

• Improves cash management and reduces unnecessary market borrowing.
• Protects bond market stability by smoothing sudden borrowing spikes.
• Shows RBI's role as banker to government without directly monetising long-term deficits.

11) Government Securities (G-Secs): The Backbone of Market Borrowing

Government securities (G-Secs) are tradable debt instruments issued by the government to borrow from the market. They carry sovereign backing, making them the benchmark "risk-free" instrument in the domestic economy (credit risk is minimal, though price risk exists).

11.1 Why G-Secs Are Important

• Benchmark yield curve: pricing reference for corporate bonds and loans.
• Monetary policy transmission: bond yields influence lending rates and financial conditions.
• Financial stability: banks hold G-Secs for SLR and liquidity management.
• Debt management: maturity and coupon choices influence rollover risk and interest burden.

11.2 Primary and Secondary Market (Simple Explanation)

• Primary market: government issues new securities through auctions.
• Secondary market: investors buy/sell existing securities; yields move based on demand, inflation expectations, and RBI liquidity stance.

12) RBI's Role in Public Debt Management

The RBI plays a central role in India's debt ecosystem. Even though the government sets borrowing needs, RBI supports the process through operational management and market development.

12.1 RBI as Government's Banker

• Maintains government accounts.
• Provides WMA for short-term needs.
• Facilitates payments and cash management.

12.2 RBI as Debt Manager (Operational Role)

• Conducts auctions of G-Secs and T-Bills on behalf of the government.
• Supports market infrastructure and settlement systems.
• Works with primary dealers to improve bidding and market making.

12.3 RBI and Secondary Market Stability

• Open Market Operations (OMOs): RBI buys/sells government securities to manage liquidity and influence yields.
• Liquidity tools: repo, reverse repo, standing facilities influence money market conditions that feed into bond yields.
• Financial stability coordination: avoids disorderly spikes in yields that can disrupt borrowing and banking balance sheets.

UPSC caution line: RBI must balance debt management support with inflation control and monetary policy independence. Excessive "support" can create perceptions of fiscal dominance.

13) Debt Sustainability: What It Means and How to Explain in UPSC Answers

Debt sustainability means the government can service its debt without default and without needing unrealistic future adjustments (like extreme tax hikes or drastic spending cuts) that can harm growth or stability.

13.1 The Core Idea (Simple, High-Scoring)

Debt is sustainable when:

• GDP growth (and revenue growth) is strong enough,
• interest rates are not persistently higher than growth,
• primary deficit is controlled (or primary surplus achieved when required),
• maturity structure reduces rollover stress,
• debt is mostly domestic currency and held by stable investors.

13.2 Interest-Growth Differential (r - g): The Key Concept

A standard way to explain sustainability is: compare r (effective interest rate on government debt) with g (nominal GDP growth rate).

• If g > r, the economy grows faster than the interest burden. Debt ratio can stabilise more easily.
• If r > g, debt servicing becomes harder, and debt-to-GDP can rise unless the government runs a primary surplus.

13.3 Primary Balance and Debt Dynamics

Primary deficit = fiscal deficit minus interest payments. If interest payments are high, even a moderate fiscal deficit can become risky. To stabilise debt, governments often need to improve the primary balance.

13.4 Other Sustainability Indicators (Very Useful for Mains)

• Interest payments to revenue receipts ratio: shows how much revenue is locked for interest.
• Average maturity of debt: longer maturity reduces rollover risk.
• Share of short-term debt: higher short-term share increases refinancing risk.
• Currency composition: higher foreign currency debt increases exchange rate risk.
• Investor profile: stable domestic holders reduce sudden shocks.
• Contingent liabilities: guarantees to PSUs, states, or special purpose vehicles can become actual debt later.

14) Debt-to-GDP International Comparison (Table)

International comparison helps you place India in context. However, remember that countries differ in economic structure, reserve currency status, demographic profile, and ability to borrow in their own currency.

Exam note: Avoid writing exact debt ratios unless you have the latest official figure. UPSC rewards conceptual clarity and correct comparisons more than risky exact numbers.

15) Timeline of Debt Management Reforms in India (Table)

Debt management in India has evolved from administered systems to more market-based borrowing with better transparency, auctions, and market infrastructure.

16) Recent Developments in Public Debt and Debt Management (UPSC-Ready)

Recent years have seen changes due to global shocks, domestic capex priorities, and evolving financial markets. Key developments you can write in Mains answers are:

16.1 Higher Borrowing Needs After Global and Domestic Shocks

• Large shocks (like pandemics and global tightening cycles) increase expenditure needs and reduce revenues temporarily.
• This leads to higher fiscal deficits and higher gross borrowing, pushing debt ratios upward.
• Policy focus shifts to restoring a credible medium-term consolidation path while protecting productive spending.

16.2 Increased Focus on Quality of Borrowing (Capex Push)

• India has increasingly emphasised capital expenditure to create productive assets.
• UPSC angle: "Debt is more sustainable when borrowed funds raise future growth and revenue capacity."

16.3 Maturity Management and Rollover Risk Reduction

• Debt managers often aim to lengthen average maturity and avoid excessive short-term refinancing pressure.
• This reduces rollover risk, especially when global interest rates are volatile.

16.4 Deepening of the G-Sec Market and Broader Participation

• Continued efforts to deepen the bond market, strengthen secondary market liquidity, and diversify investors.
• Retail access initiatives improve financial inclusion and widen the investor base.

16.5 Sovereign Green Bonds and Thematic Borrowing

• Use of green/thematic bonds helps align borrowing with climate commitments and green infrastructure needs.
• UPSC GS3 linkage: climate finance, green transition, sustainable infrastructure.

16.6 Centre-State Debt Coordination and Federal Fiscal Issues

• States have higher responsibilities for health, education, and welfare, so their borrowing and fiscal path matters.
• Consent-related issues under Article 293 and debates on fiscal autonomy can become important in polity-federalism answers.

17) Challenges of Public Debt in India

To score well in UPSC, write challenges in a structured manner: fiscal, macroeconomic, market, and governance/transparency.

17.1 Fiscal Challenges

• High interest payments: a large part of revenue receipts may go into interest servicing, reducing space for development spending.
• Debt rollover: if many securities mature together, refinancing pressure rises.
• Persistent primary deficits: if primary deficit continues, debt ratio tends to rise unless growth is very strong.

17.2 Macroeconomic Challenges

• Crowding out: heavy government borrowing can raise interest rates and reduce credit availability for private investment.
• Inflation risk: if fiscal dominance leads to loose monetary conditions, inflation expectations can rise.
• Lower fiscal flexibility: high debt reduces the ability to respond to future shocks.

17.3 External Sector and Currency Risks (for External Debt)

• Exchange rate risk: rupee depreciation increases repayment burden.
• Global rate cycles: global tightening increases borrowing costs and refinancing risk for external liabilities.

17.4 Transparency and Off-Budget Concerns

• Hidden liabilities: guarantees, PSU borrowings, and special purpose vehicles can create contingent liabilities.
• Off-budget financing: if borrowing is shifted outside the budget, true fiscal position becomes harder to judge.

17.5 Centre-State Coordination Challenges

• States' borrowings (including SDLs) affect overall public debt and market yields.
• Need coordination to avoid excessive combined borrowing pressure in a single year.

18) Way Forward: How India Can Strengthen Debt Sustainability

A high-quality UPSC "way forward" must be practical, balanced, and linked to growth, fiscal rules, and governance.

18.1 Strengthen Medium-Term Fiscal Framework (Not Just Annual Targets)

• Follow a credible medium-term path for deficit reduction with clear milestones.
• Use flexibility during shocks but return to the path once conditions normalise.
• Improve transparency with realistic assumptions and regular reporting.

18.2 Improve Quality of Expenditure

• Protect capital expenditure: capex improves future growth and tax base.
• Rationalise subsidies: shift from poorly targeted subsidies to direct and efficient support where needed.
• Outcome-based budgeting: improve efficiency of every rupee spent.

18.3 Enhance Revenue Mobilisation

• Improve tax buoyancy through better compliance and widening the base.
• Strengthen non-tax revenues where possible (dividends, spectrum, user charges) while maintaining equity.

18.4 Deepen Bond Markets and Diversify Investor Base

• Improve secondary market liquidity to reduce borrowing costs.
• Encourage long-term investors (pension, insurance) and stable participation.
• Develop the corporate bond market so that private sector financing does not over-depend on banks.

18.5 Improve Debt Transparency and Manage Contingent Liabilities

• Publish comprehensive debt statements and risk assessments.
• Monitor guarantees and ensure proper pricing and caps.
• Reduce off-budget borrowings and bring liabilities on-budget where feasible.

18.6 Strengthen Centre-State Fiscal Coordination

• Encourage fiscal responsibility at state level with incentives for reforms and capex efficiency.
• Improve coordination in borrowing calendars to reduce market pressure.
• Support states with capacity building for debt and cash management.

19) UPSC PYQs (Write in Answer Format)

20) Prelims-Focused Quick Revision Points

• Article 292: Centre borrowing power; limits fixed by Parliament.
• Article 293: States borrowing power within India; Centre consent needed if States are indebted to Centre (conditions may apply).
• Internal debt: domestic borrowing; mainly rupee-denominated; includes market loans, T-bills, small savings.
• External debt: foreign sources; includes multilateral and bilateral loans; economy-wide also includes ECBs, NRI deposits, trade credit.
• Debt-to-GDP: debt burden indicator; interpret with growth, interest rate, maturity, holders.
• FRBM: rule-based fiscal discipline; aims to manage deficits and improve debt sustainability; includes escape clause idea.
• WMA: short-term advances by RBI for cash mismatches; not for long-term deficit financing.
• G-Secs: primary instrument of market borrowing; benchmark yields for the economy.
• Debt sustainability: depends on r-g, primary balance, maturity, currency mix, investor base, contingent liabilities.

21) Mains Practice Questions (Answer Writing)

1. "Public debt is not a problem if it finances productive capital formation." Critically examine in the Indian context.

2. Explain the constitutional provisions related to government borrowing in India. How do these provisions affect fiscal federalism?

3. Discuss the instruments of internal debt in India and evaluate the role of G-Sec market deepening for debt sustainability.

4. What is debt sustainability? Explain the importance of interest-growth differential and primary balance in debt dynamics.

5. Assess the role of RBI in government debt management. How can India balance debt management needs with monetary policy independence?

22) Practice MCQs (8) with Answers and Explanations

Q1. Which of the following correctly matches the constitutional provisions related to borrowing?

• (a) Article 292 - States; Article 293 - Centre
• (b) Article 292 - Centre; Article 293 - States
• (c) Article 280 - Centre borrowing; Article 292 - Finance Commission
• (d) Article 360 - Borrowing powers of States

Answer: (b)

Explanation: Article 292 empowers the Union (Centre) to borrow upon the security of the Consolidated Fund of India within limits fixed by Parliament, while Article 293 deals with States' borrowing (primarily within India) and related conditions.

Q2. Internal public debt in India primarily includes which of the following?

• (a) Treasury Bills and dated Government Securities
• (b) Multilateral loans and bilateral loans
• (c) External Commercial Borrowings (ECBs)
• (d) IMF emergency financing as a regular source

Answer: (a)

Explanation: Internal debt is raised domestically and includes market loans (dated G-Secs) and short-term instruments like T-bills, along with non-marketable domestic liabilities such as small savings.

Q3. Which of the following is the most direct risk associated with higher external debt (public external debt) compared to internal debt?

• (a) Liquidity risk in domestic money markets
• (b) Exchange rate risk increasing repayment burden in domestic currency
• (c) Higher SLR requirements for banks
• (d) Reduction in domestic savings rate by definition

Answer: (b)

Explanation: External debt often involves foreign currency exposure. If the domestic currency depreciates, repayment in domestic currency becomes more expensive, increasing fiscal/external vulnerability.

Q4. Ways and Means Advances (WMA) are best described as:

• (a) Long-term loans given by RBI to finance capital expenditure
• (b) Permanent monetisation of fiscal deficit by RBI
• (c) Short-term advances by RBI to bridge temporary cash flow mismatches of government
• (d) External borrowing from multilateral institutions routed through RBI

Answer: (c)

Explanation: WMA are temporary advances from RBI meant for short-term cash management. They are not designed to finance long-term deficits.

Q5. Debt-to-GDP ratio is an important indicator, but it has limitations. Which of the following statements best captures a key limitation?

• (a) It always shows the exact default probability of a country
• (b) It ignores factors like maturity profile and interest-growth dynamics
• (c) It measures only external debt and not internal debt
• (d) It cannot be used for any international comparison

Answer: (b)

Explanation: Debt-to-GDP is a useful proxy, but sustainability depends on many factors such as maturity (rollover risk), who holds the debt, and whether growth exceeds the effective interest rate (r-g).

Q6. Consider the following statements about Government Securities (G-Secs):

• 1. They are a benchmark for pricing other debt instruments in the economy.
• 2. They can be issued only as short-term instruments.
• 3. Their yields influence monetary policy transmission through the financial system.
• (a) 1 and 2 only
• (b) 2 and 3 only
• (c) 1 and 3 only
• (d) 1, 2 and 3

Answer: (c)

Explanation: G-Secs include both short-term (like T-bills) and long-term (dated securities). They provide the benchmark yield curve and influence broader financial conditions, supporting monetary transmission.

Q7. The concept of interest-growth differential (r-g) is used in debt sustainability analysis. If nominal GDP growth (g) persistently exceeds the effective interest rate (r), then:

• (a) Debt-to-GDP ratio can stabilise more easily, even with moderate deficits
• (b) Debt-to-GDP ratio must rise sharply in all cases
• (c) External debt automatically becomes zero
• (d) Government does not need any fiscal planning

Answer: (a)

Explanation: When g > r, the economy's income base grows faster than the interest burden, making it easier to stabilise or reduce the debt ratio, though primary balance and other risks still matter.

Q8. Which of the following is a credible "way forward" measure to improve public debt sustainability in India?

• (a) Cutting productive capital expenditure first to reduce deficits
• (b) Relying mainly on short-term borrowing to reduce coupon costs
• (c) Strengthening medium-term fiscal framework, improving revenue mobilisation, and protecting high-quality capex
• (d) Increasing off-budget borrowings to keep reported debt low permanently

Answer: (c)

Explanation: Sustainable strategy focuses on credible medium-term consolidation, better revenue mobilisation, expenditure efficiency, and productive capex that raises future growth and repayment capacity. Over-reliance on short-term debt raises rollover risk, and off-budget borrowing harms transparency.

23) Conclusion

Public debt is a powerful policy tool when used responsibly. For India, the key strengths are the dominance of domestic, rupee-denominated debt and a relatively stable investor base. The key concerns are interest burden, rollover needs, and the need to maintain a credible path under a flexible but disciplined fiscal framework. In UPSC answers, always connect public debt to growth quality, fiscal credibility, RBI's balancing role, and long-term sustainability rather than treating debt as only a negative concept.