India’s consolidated fiscal deficit may increase to 10.3% of GDP in FY09 and 10% of GDP in FY10, according to our estimates, due to the cyclical downturn in tax revenues, election-related spending, and a large subsidy bill. The deficit will come down substantially over the next few years due to a structural increase in spending, especially on higher wages and unemployment benefits, as well as a large increase in the government’s interest burden-which is over 50% of the FY09 fiscal deficit. Although the debt ratio is sustainable under most scenarios, a continued slowdown in GDP growth could cause it to rise unsustainably.
Although the stimulus comes at an opportune time for the rapidly slowing economy, government spending may be permanently increased. The government’s borrowing program will rise dramatically to a budget estimate of US$65 billion in FY10 from US$28 billion in FY08, and will likely remain at elevated levels.
India’s debt had been on a declining trend since FY04 due to high growth, and falling primary deficits. The current upsurge will reverse that trend. It is expected to hit record levels in FY10.