Global public debt has almost crossed $100 trillion, a figure nearly equivalent to the global economy’s annual output. The International Monetary Fund forecasts that this debt could approach 100 per cent of global GDP by the end of this decade.
India, with a general government debt of approximately 81 per cent of GDP, is positioned slightly above the average for emerging markets. While this may appear manageable, a recent IMF working paper indicates that the margin for error is narrower than it seems. If the global community is indeed operating on borrowed time, India must ask whether it is also relying on borrowed trust.
The credibility premium
Central to this challenge is the concept termed P-Theory, outlined in IMF’s October 2025 working paper, “Maximum Sustainable Debt Across Countries: An Assessment using P-Theory,” authored by economists Yongquan Cao, Wei Jiang, W. Raphael Lam, and Neng Wang. This theory proposes that government debt is not just another accounting entry, but a contract upheld by credibility. While traditional models maintain that solvency is assured as long as the government can refinance its obligations, P-Theory introduces an additional critical dimension: the market’s assessment.
This assessment is articulated through interest rates, bond spreads, and the “convenience yield”—the premium investors earn for holding secure, liquid sovereign bonds. Advanced economies benefit from this premium; many emerging markets do not. As a result, debt sustainability becomes more dependent on institutional trust than on cash flows. It is precisely this trust, rather than growth alone, that determines how far a nation can extend its debt before credibility becomes a limiting factor.
The IMF’s cross-country analysis provides insightful findings: advanced economies can sustain debt levels averaging approximately 124 per cent of GDP, emerging markets around 76 per cent, and low-income economies roughly 57 per cent. These thresholds reflect institutional depth, market liquidity, and policy credibility—not just income levels. India’s general government debt, at approximately 81-82 percent of GDP, thus positions it slightly above the emerging-market average. And while its 6.5-7 per cent growth rate is among the highest globally, rapid growth does not automatically create fiscal space, particularly when interest costs are escalating or credibility is fragile.
When debt servicing begins to encroach upon development expenditure, credibility must be reconceptualised as a growth strategy rather than a constraint.
Moving target of fiscal space
India’s fiscal framework exhibits both resilience and vulnerability. More than 90 per cent of its debt is rupee-denominated and held domestically, providing a buffer against external currency fluctuations. However, interest payments already account for about 24-25 per cent of the Union government’s total expenditure, making it the largest single budgetary item. With ten-year government bond yields projected to remain between 6.3 per cent and 6.6 per cent through 2025, any persistent increase in yields could rapidly diminish fiscal flexibility. When debt servicing begins to encroach upon capital expenditure, fiscal prudence becomes not just a virtue but a growth strategy in itself.
Revenue generation presents an additional constraint. India’s tax-to-GDP ratio is approximately 11-12 per cent, with consolidated government revenue, including non-tax receipts, nearing 20 per cent of GDP. These figures are significantly lower than the 30-40 per cent observed in advanced economies.
The IMF’s P-Theory model identifies tax capacity as a crucial determinant of sustainable debt: nations with stronger revenue-generating capabilities can borrow more without shaking market confidence. For India, the challenge goes beyond fiscal consolidation to encompass the broader task of enhancing fiscal capacity—expanding the tax base, simplifying compliance, and increasing transparency across both central and state budgets.
According to P-Theory, the ceiling on sustainable debt is not fixed; it fluctuates with changes in growth, interest rates, and credibility. When growth surpasses interest rates, debt can stabilise. However, as this gap narrows, even a modest increase in global real interest rates—just 0.5 percentage points in IMF simulations—can significantly lower the sustainable-debt limit for emerging markets.
For instance, Brazil’s estimated debt ceiling fell from approximately. 114 per cent of GDP in 2014 to about 91per cent in 2017 as growth slowed, before rising again to over 100 per cent by 2024. Similarly, the US saw its ceiling drop as yields increased post-pandemic. India’s fiscal comfort zone, therefore, is conditional—dependent on market perceptions of its trajectory.
Ultimately, perception is grounded in credibility—the intangible asset that defines a sovereign’s strength.
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The new economics of prudence
Within the framework of P-Theory, credibility is not a moral virtue but a form of economic collateral. Countries with transparent budgeting, predictable fiscal trajectories, and reliable institutions can secure loans at lower costs, as investors perceive their intentions as credible. P-Theory incorporates this notion through the default-cost parameter: the greater the economic repercussions of failing to meet commitments, the higher the borrowing capacity.
India’s fiscal record is showing signs of improvement, with the central government pledging to reduce the fiscal deficit to around 5.1 per cent of GDP by FY 2026. However, state finances remain varied, and off-budget liabilities, such as public-sector guarantees, are often under-reported. Enhancing transparency around these contingent liabilities could actually enlarge India’s credibility premium and subsequently lower effective borrowing costs.
It is crucial to recognise that borrowing is not inherently imprudent; its sustainability depends on how it is used. Debt allocated to infrastructure, renewable energy, health and education sectors enhances future output and extends the sustainable debt limit. Conversely, debt spent solely on consumption or temporary subsidies weakens the balance sheet without building capacity. India has already shifted towards capital-intensive expenditure, but maintaining this focus will be increasingly vital as global liquidity becomes constrained.
The broader insight from the IMF’s new framework is that fiscal space must be earned through discipline, capacity, and credibility—not assumed. Sustainable debt is not defined by a single magic number but emerges from the interplay of growth, interest rates and trust. Advanced economies borrow more not solely due to their wealth but because markets have confidence in their regulatory frameworks and repayment discipline. Emerging markets, such as India, must cultivate this belief.
As the era of easy money wanes, the distinction between the capacity to borrow and the credibility to borrow will be pivotal in defining fiscal resilience. India still has the opportunity to expand both by strengthening its tax base, ensuring transparent fiscal reporting, and channelling debt into productive investments. While the country’s growth prospects remain robust, its fiscal future will depend less on the volume of borrowing and more on its ability to convincingly demonstrate its financial sustainability. Trust remains the rarest form of capital.
Bidisha Bhattacharya is an Associate Fellow, Chintan Research Foundation. She tweets @Bidishabh. Views are personal.
(Edited by Ratan Priya)