Direction (Q. 1 - 10): Read the following passage and answer the questions that follow:
Should we be concerned about high and sharply-rising public debts? Opinion is divided. Optimists point to how in the aftermath of World War II, government debts in excess of 100% of gross domestic product (GDP) were common. Yet there were no defaults.
So, is it possible that worries about excessive public debts are exaggerated even if the unfolding Greek tragedy suggests otherwise? After all, barring a few exceptions, nominal government bond yields have remained low and have fallen in some cases.
Will that happy state of affairs continue? A recent BIS paper is less hopeful. It warns that governments should not be lulled into complacency by the ease with which they financed their deficits in the past.
For one, to the aftermath of the financial crisis; future output is likely to be permanently lower for'a while. As a result, government revenues will be lower and expenditures higher, making consolidation more difflc't
Moreover, large public debts have significant financial and real consequences. The recent sharp rise in risk premia on long-term bonds issued by several industrial countries suggests that markets no longer consider sovereign debt lowrisk. In addition, the impact of high debt-GDP ratios on growth is non-linear, with adverse output effects tending to rise as the debt-GDP ratio approaches the 100% limit.
In addition to higher risk premia and increased cost, a second risk associated with high levels of public debt comes from potentially lower long-term growth. A higher level of public debt implies that a larger share of society's resources is permanently being spent servicing the debt. This means that a government intent on maintaining a given level of public services will have to raise more taxes. There is also the possibility of crowding out of private investment.
Last but not least, the existence of a higher level of public debt is likely to reduce both the size and the effectiveness of a future fiscal response to an adverse shock.This was evident during the latest crisis. Countries saddled with very high public debt did not expand fiscal policy as much as other countries.
From the monetary policy perspective, deteriorating public finances can trigger a sudden increase in long-term initiation expectations. When the public is no longer willing to hold public debt, the government may have to resort to monetisation. Anticipation of this may lead to an increase in inflation today as investors reassess the risk from holding money and government bonds. In such an environment, fighting rising inflation by tightening monetary policy would not work, as an increase in interest rates would lead to higher interest payments on public debt, leading to higher debt, bringing the likely time of monetisation even closer.
Second, uncertainty about the timing and extent of fiscal consolidation plans complicates the central bank's ability to forecast where policy rates need to be set.
A high public debt raises the risk of political and economic pressures on monetary policymakers to inflate away the real value of debt. The payoff to doing this rises. The larger the size of the debt, the longer its average maturity. The larger the fraction denominated in domestic currency, and the bigger the fraction held by foreigners.
For now, we in India can take comfort from the fact that our public debt-to-GDP ratio is nowhere near 100%. But what is undeniable is that if we include the debt of public sector undertakings and other quasi-government entities in our debt-GDP ratio, the picture will look much more alarming. Inflation is already high and, unlike many advanced countries, there is no appetite for Indian paper overseas. It helps, of course, that the debt is in rupees and we also have a high domestic savings ratio; but don't count on it.
In the passage, the author expresses concern about unwise