Reducing poverty requires states to maintain economic growth and, importantly, to increase investments in the social sector. Government debt can, however, be a heavy burden. In India, such debt may stop several states from reaching their Millennium Development targets for poverty reduction. 

A paper from the World Institute for Development Economics Research, in Finland, explores how government debts affect progress towards the Millennium Development Goals (MDGs) for poverty reduction.  Major social sector investments will be needed to achieve these targets. Whether developing world governments can do this depends on the condition of their finances.

Government debt is an indicator of financial health. While large government debt can reflect social sector spending, high interest payments on debts are likely to lead to cuts in social programmes for poor people. In many Indian states, and not only the poorer ones, servicing government debt consumes most of annual expenditure, leaving little for development.

Debt can also slow economic growth, which in turn affects poverty levels. Higher debt can raise taxes and discourage long-term investments, including in education and health. This can create economic uncertainty. The authors find there is a decreasing trend in poverty in Indian states, but an analysis of the links between debt, social spending (focusing on health) and income levels reveals that:

• If health expenditure remains constant, increased debt will increase poverty and even an increase in income will not significantly reduce poverty.
• Increasing debt increases poverty twice as much as increases in health expenditure or Gross Domestic Product per capita would reduce poverty; the more the debt, the faster poverty increases.
• On average, India was on target to meet its MDG targets for 2007, so in the medium term state debt may not have much of a negative effect on poverty.
• If only the impact of government investment in the social sector is considered, most major states meet the 2007 MDG targets, although states with low poverty levels may miss their targets largely because they need to invest more to have a significant effect.
• When government debt is taken into account the number of states that could not to meet the 2007 MDG targets increases.
• Given current trends in debt and health spending, on average, Indian states will not be able to meet 2015 MDG targets. Even reducing debt and increasing health spending will not be enough for many states, unless debt reduction is significant.

The author concludes that:

• Increasing debt and health spending by similar proportions will lead to an increase in overall poverty, as debt has a stronger effect on poverty.
• Increasing debt to fund social expenditure is therefore not a good strategy: the focus should be on reducing debt.
• Further research is required, using comprehensive data on social spending, and also to explore why some states consistently achieve their targets while others do not.

Source(s):
‘The Burden of Government Debt in the Indian States: Implications for the MDG Poverty Target’, UNU-WIDER Research Paper No.2007/14, UNU-WIDER: Helsinki, by Indranil Dutta, 2006 (PDF) Full document.

Funded by: Department for International Development (United Kingdom)

id21 Research Highlight: 25 April 2008

Further Information:
Indranil Dutta
UNU-WIDER
Katajanokanlaituri 6 B
FIN-00160 Helsinki
Finland

Tel: +358 9 61599218
Fax: +358 9 61599333
Contact the contributor: dutta@wider.unu.edu

UNU World Institute for Development Economics Research (UNU/WIDER)

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