Page 75 - ES 2020-21_Volume-1-2 [28-01-21]

58 Economic Survey 2020-21 Volume 1

because the bond has to be repaid using fiat domestic currency, which is in turn a claim on the
nation’s output. Therefore, debt denominated in the domestic currency is in effect a claim on
the nation’s (future) output. Seen this way, an interesting parallel arises between the costs of
dilution from fresh equity issuance and costs due to inflation, which essentially dilutes the value
of future output, when more money is printed. Incumbent equity holders in a company see their
ownership diluted when the company issues stock to new equity holders at a price below its
intrinsic value. This, however, does not mean that any stock issue necessarily involves dilution
of value for incumbent equity holders. As Stein (1996) and Baker, Stein and Wurgler (2003)
have argued, corporations can also be in situations where they are able to issue new shares when
the company’s share is overvalued. In such situations, the equity issue, in effect, results in more
valuable ownership for incumbent shareholders. Similarly, printing more money can result in
inflation and loss of purchasing power for domestic residents if the increase in money supply
is larger than the increase in output. However, as with new stock issues and dilution, printing
more money does not necessarily lead to inflation and a debasement of the currency. In fact, if
the increased money supply creates a disproportionate increase in output because the money
is invested to finance investment projects with positive net present value (where such value
incorporates all the societal value generated by the investment), the increased money supply is
beneficial to the citizens.

2.12 Evidence over the last two-and-a-half decades demonstrates clearly that in India, higher
GDP growth causes the ratio of debt-to-GDP to decline but not vice-versa. An examination of
the contemporaneous correlation between real GDP growth and ratio of general government
debt-to-GDP – though clearly negative and statistically significant as seen in Figure 7 – does not
provide clarity about the direction of causation.
2.13 Inferring the direction of causation that manifests in India is important because the negative
contemporaneous correlation seen in Figure 7 can be incorrectly interpreted as higher debt causes
the GDP growth rate to decline, when it is possible that the direction of causation is exactly the
opposite – higher GDP growth rate causes the debt as a percentage of GDP to decline.

Figure 7: Contemporaneous relationship GDP growth and change in general
government debt for india (FY 1996 to FY 2020)

Source: RBI, MoSPI