For designing an appropriate stimulus package in the Indian scenario, where fiscal deficit is estimated (Macro Team�s estimates) to be more than 8 percent (Combined centre and state with off budget items also included, 2008-09) and the ratio of public debt to GDP around 73, one of the crucial questions is the sustainability of the high level of public debt. In last few years there has been a downward movement in the public debt to GDP ratio in India. The Twelfth Finance Commission had set the optimal ratio of public debt to GDP as 55 percent in 2004-05. It is currently significantly higher. Internationally, the Maastricht Treaty had set the favorable debt level to around 60 percent of GDP. Other considerations like the level of primary deficit, fiscal deficit, the differential between GDP growth and interest rates and the external debt component in total debt have also to be looked into for ensuring debt sustainability.
For the Indian economy it has been found (Rangarajan and Shrivastava 2005) that for the period 1955-2000 that primary deficit was the core variable that led to increase in debt to GDP ratio. The public debt to GDP ratio in the beginning of the first plan period (1950-51) was around 29 percent which had risen to the peak of around 83 percent in 2003-04. Even with positive primary deficit for a long period of time, the debt to GDP ratio was contained due to the faster growth of GDP as compared to the real interest rates. Rangarajan (2003) had found that during the 1970�s and 1990�s negligible increase was seen in the debt-GDP ratio because nearly 100 percent of the impact of the primary deficit was absorbed by the growth interest differential.
If we try to evaluate the soundness of the Indian economy through these parameters the picture is some what mixed. The positive factor is that we have been running a primary surplus since 2006-07 and recently available data for 2008-09 (budget estimates) indicate a rather low level of primary deficit of around -0.8. But these estimates may have to be seriously revised because there has been huge increases in government expenditure which will raise the level of the primary deficit. As regards the growth interest differential there may be concern as the GDP growth rate would come down sharply in the coming years and interest rates may come down only with a lag. However, India has one other major advantage of having very low external debt as a share of total debt. India has less than 4 percent (2008-09) as their external liabilities of the centre to the total public debt. Thus, the most volatile component of debt is extremely small. While this is a silver lining, we cannot still allow the total public debt to go far beyond the levels as recommended by the Twelfth Finance Commission or the Maastricht Criteria. This implies that there is not much fiscal headroom for stimulating domestic demand. This is a pity as monetary measures need to be supplemented by fiscal expansion for the counter cyclical measures to become effective. This is especially true in a downturn when the consumption propensity is likely to decline and the monetary multiplier is weak.