Friday, December 4, 2020

How Much Debt Is Too Much?

Very interesting article by Raghuram Rajan, especially this para. on how much debt a government can issue.
“It is not enough for a government to ensure that it can afford to make its interest payments; it also must show that it and its successors can repay the principal. ……investors will buy new debt only if they are confident that the government can repay all its debt from its prospective revenues.
The investor in new debt needs to be confident that the government’s current and future tax revenues will be sufficient to repay its accumulated debt. There is a limit, but if the funds raised through new debt are invested in high-return infrastructure projects, it probably will never be tested – additional future revenues will pay for the additional debt. If, however, the money is spent on much-needed support for poor and vulnerable households, the limit eventually will come into view."
One “ option is to allow for higher inflation, which would erode the stock of debt denominated in current rupees vis-à-vis future tax revenues. Inflation, in this case, would emerge not because the economy is at full employment …….. but rather because the government had reached the limits of the debt it can repay. New debt holders would demand higher interest rates – including perhaps a premium for inflation risk – and the curtain would drop on the era of ultra-low interest rates and unlimited borrowing.” ,which seems to be our present predicament.
R.Rajan warns us that if we keep on encouraging higher spending but not higher revenues – as many an emerging market is doing, it would not be surprising to see somewhat higher inflation very soon. Payadachy and Sithanen among others, who had recommended "helicopter" money and played down its inflationary impact should pay attention to this note of caution by Rajan.
Rashmee Daby, Jose Moirt and 2 others
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