Debt has become the default instrument of economic policy across much of the world. In the decade following the global financial crisis—and again after the pandemic—governments increasingly relied on borrowing to sustain growth, stabilise incomes and finance public investment. The result has been a sharp rise in public debt almost everywhere.
The more relevant question today is not whether debt is high, but whether it is productive. Over long horizons, economies succeed when borrowing expands productive capacity faster than the cost of servicing that borrowing. Where this condition fails, debt eventually constrains growth rather than enabling it.
Imagine a household buying its first home with a mortgage. The loan is manageable, payments fit comfortably within income, and as earnings rise over time, the debt feels lighter. This is leverage working as intended.
Encouraged by rising prices, the household buys a second home, again mostly on debt. Rental income covers part of the cost, and salary growth fills the rest. Leverage still works because income broadly keeps pace with obligations.
Now imagine a third and fourth property. Income growth slows, but borrowing continues. Maintenance costs rise, interest rates fluctuate, and cash flows tighten. On paper, the household looks wealthier. In reality, the margin for error has disappeared. Any shock—a job loss, a rate hike—forces difficult choices.
This is the point at which debt stops being fuel and starts becoming ballast.
The parallel with public finances is clear. Governments can carry rising debt so long as income grows faster than obligations. Trouble begins when borrowing continues even as income growth slows, or when debt funds consumption rather than assets that raise future earning power.
Some economies resemble the prudent first homeowner. Others look closer to the over-leveraged investor, relying on growth to arrive on schedule. History suggests it rarely does.
A useful way to frame this trade-off is to compare the growth of government debt with the growth of per-capita income. If incomes rise faster, debt becomes more manageable over time. If debt outpaces income, leverage accumulates—even if headline GDP growth appears healthy.
Viewed through this lens, global outcomes diverge markedly.
A Global Divide
A small group of economies—most notably Vietnam and Taiwan—have managed to align debt growth closely with per-capita income growth over the past decade. Their success rests on export-led growth models, strong manufacturing or technology ecosystems, and relatively disciplined fiscal frameworks. Singapore, often cited for its high gross debt, remains a special case: its liabilities are matched by financial assets, making conventional debt metrics misleading.
At the other end of the spectrum lie economies such as China, Brazil and South Africa, where debt has expanded substantially faster than per-capita income. In China’s case, the issue is not simply the level of debt but its concentration in local governments and property-linked financing vehicles, which has reduced the productivity of incremental borrowing.
Between these two groups sit several large emerging economies—including India—where income growth remains strong but debt has begun to rise more rapidly. This is not yet a point of stress. But it is a signal worth taking seriously.
India’s Aggregate Strength—and Its Hidden Risk
At the national level, India’s macroeconomic position remains comparatively favourable. The country benefits from a long demographic runway, a large domestic savings pool, and public debt that is overwhelmingly denominated in local currency. Its digital public infrastructure has also improved fiscal capacity and targeting efficiency.
Yet India’s government debt has grown faster than per-capita income over the past decade, reflecting infrastructure investment, expanded welfare spending and pandemic-related support. So far, growth has been sufficient to absorb this increase.
The more important vulnerability, however, lies below the surface.
India is fiscally decentralised to an extent few large economies are. Its states account for a substantial share of public spending and borrowing—and they differ enormously in economic structure, revenue capacity and policy quality.
Thirty Economies, One Sovereign
A small number of Indian states—such as Karnataka, Haryana, Gujarat, Tamil Nadu and Telangana—have come close to maintaining a balance between debt growth and per-capita income growth. These states benefit from stronger urbanisation, export exposure, and higher productivity sectors.
Most states do not.
Across much of India, state-level debt has grown significantly faster than per-capita income. This reflects borrowing directed towards consumption subsidies, transfers and recurrent expenditures rather than productivity-enhancing investment. Over time, such patterns weaken fiscal resilience.
Unlike the central government, states operate under hard constraints. They cannot issue currency. They cannot adjust exchange rates. And their capacity to refinance debt depends increasingly on central transfers and market confidence. Persistent divergence between debt growth and income growth at the state level therefore poses a structural risk to India’s medium-term growth trajectory.
The Long-Term Implications
Debt dynamics evolve slowly. Problems rarely emerge in the early stages, when growth is strong and financing conditions are benign. The difficulty arises later, when demographic tailwinds fade and growth normalises, leaving less room to absorb accumulated obligations.
International experience is clear: economies that sustain high growth over decades use debt to raise productivity, not to defer adjustment. Where borrowing substitutes for reform, growth eventually slows.
India today sits between these two paths.
What Needs to Change
If India is to sustain high growth over the next three to four decades, the focus of reform must shift decisively towards state-level fiscal quality.
First, borrowing frameworks should be more explicitly linked to economic outcomes. States that demonstrate durable improvements in income growth, export capacity and urban employment should have greater fiscal space than those that do not.
Second, India’s fiscal rules need updating. Headline deficit targets matter less than the relationship between debt servicing costs, revenue growth and per-capita income. A revised framework should reflect this reality.
Third, off-balance-sheet liabilities—particularly in power, transport and urban infrastructure—should be fully consolidated. Hidden debt undermines accountability and delays adjustment.
Fourth, incentives must be aligned. States that manage debt prudently and grow incomes faster should be rewarded through lower borrowing costs or greater autonomy.
Finally, India must accelerate urban productivity. Cities remain the country’s most underutilised growth engine. Property taxation, user charges and municipal finance reform are essential to reducing pressure on state balance sheets.
A Narrowing Window
India’s public debt is not yet a binding constraint. But the margin for error is shrinking. Over time, the difference between debt that enables growth and debt that merely sustains spending becomes decisive.
International comparisons offer a clear lesson. Economies such as Vietnam and Taiwan show how disciplined borrowing can support long-term prosperity. Others illustrate the costs of postponing adjustment.
India still has the opportunity to choose the former path. Whether it does so will depend less on national ambition than on how its states choose to borrow, invest and reform.
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