When Obama had to borrow to repay his loans!

There is a lot of buzz being generated all over the world over the debt-ceiling issue of the US of A. No day goes without a front-page article on the issue. This article tries to give you a basic understanding of the whole issue and gives insights into the Indian scenario too.

What does the debt ceiling mean?

In simple terms, it is the maximum amount that the government can borrow to fund its day to day functioning. The current debt ceiling is at 14.294 Trillion dollars. This means that the US Government cannot borrow more than this limit without the permission of the congress.

So what?

Today the US is faced with a situation where it does not have money to repay its debtors nor to run the day-to-day expenses of the Government. This means it has to borrow to keep the ship running. However, since it has already used up the limit, it is in a quandary. Borrowing more means more debt, not borrowing means defaulting on payments!

Why has this happened?

It all boils down to simple math. Spend lesser than what you earn. But in the eagerness to get the economy’s growth boosted, the US government has borrowed more and spent more. Correspondingly the income/revenue has not risen.  A few of the reasons are the increased expenses for the wars that America is fighting in Asia and also cutting taxes for the super rich.

What is the way out?

A very practical way out is to cut total spending so that the gap between income and expenditure reduces and the government does not need to borrow. Nevertheless, this is a very tricky situation as trying to cut spending means taking the risk of depressing growth!

The only other way is to borrow more and stay afloat till the effects of expenditure cuts trickle down or incomes increase.

The India Story

The Indian government does not have a debt ceiling in a manner of speaking. Rather the annual budget sets a target on the fiscal deficit. The target for 2011-12 is 4.6% of GDP (Gross Domestic Product). This means that the government can spend 4.6% of GDP more than what it is going to earn as income.

Recent estimates have pegged the Indian GDP at Rs 90 Lakh Crore (approximately 2 Trillion USD).

Current Indian debt is around 40 Lakh Crore (aprrox 0.9Trillion USD)

The current budget has estimated income of Rs 10.5 Lakh Crore and Expenditure of 12.57 Lakh Crore. A deficit of around Rs 2.07 Lakh Crore (0.05 Trillion USD).

The above numbers mean that India has borrowed an amount equivalent to close to 45% of its GDP or to put it in other terms, the Government of India has borrowed 4 times its annual Income. However, its expenses exceed income meaning that every year the outstanding debt is only increasing.

So why is no one worried?

The funny part is all of this has to do with the play of words! Although when we calculate in pure numbers we calculate deficit as (income-Expenditure) but when quoting it as a percentage the Government talks of it as a percentage of the GDP, which is a much larger number, and hence the deficit seems less (4.5%).

The actual deficit is 2.07 Crore divided by Rs 10.5 Lakh crore or close to 20%!!!

Food for thought? We are not in a great situation either. Where is the government going to find money to repay its loans when it does not have money to run the daily show!

Moral of the story: How imprudent would it be for a common man to take a personal loan to repay the EMI of a home loan! Likewise, although one of the fundamental rules of debt management and financial management dictates one to avoid borrowing to repay another borrowal, most governments have ignored it. The US is facing the heat. India is not far away from facing the heat either!