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Does Growth Lead to Debt Sustainability? Yes, But Not Vice-Versa! 75

26c. Minimum real growth rate from FY22, 26d. Maximum interest rate from FY 22,
above which debt is sustainable below which debt is sustainable

Source: RBI, MoSPI, Survey Estimates
Note: g: nominal growth rate
Figure 31 c and 31 d show that for a given level of sustainable debt, the IRGD will remain negative

2.40 The results depicted in Figure 26a suggest that in a worst case scenario where the real
growth is only 4 per cent in the next 10 years, public debt is sustainable. The results in Figure
26b-d also show that even at high primary deficits, low real growth and high nominal interest
rates, India’s debt will remain sustainable.

POLiCY iMPLiCATiONS

2.41 As argued above, the Covid-19 pandemic has created a significant negative shock to
demand. The various costs of financial distress that firms face even before potential bankruptcy
(Andrade and Kaplan (1998), Hotchkiss et al. (2008), Senbet and Wang (2010)) combined with
possible firm bankruptcies in a choked bankruptcy system, on the one hand, and the possibility
that jobs lost during the lockdown may not get fully retrieved, on the other hand, create the
possibility of economic hysteresis that must be avoided at all costs. The World Economic
Outlook (October 2020) edition highlights this in the case of India (see Figure 27). To eliminate
the possibility of growth being impacted in the medium to long run, the Government has been
extremely pro-active in launching several seminal reforms. However, their impact will manifest
in the medium to long-term. To ensure that the economy remains in good health to avail the full
benefit of these significant reforms, the “economic bridge” to the medium and long-term has to
be created. Only an active fiscal policy – one that recognises that the risks from doing too little
are much more than the risks from doing too much – can ensure that this “economic bridge” is
well laid out.
2.42 Central to this change in policy stance is the recognition that if we apply the old framework
to today’s reality, if we fail to stimulate the economy, we risk the temporary weakness in
demand leading to lower potential growth (Blanchard et al. 2015). With the IRGD expected to
be significantly negative for India in the foreseeable future, pro-cyclical fiscal policies may lead
to higher, not lower, debt/GDP ratios.