India’s growth prospects have brightened just as the world economy is becoming a more expensive place in which to borrow. This month, the IMF has raised its growth forecast for India to 7 percent, while the World Bank and the Organisation for Economic Cooperation and Development put it at 7.1 percent this financial year. These assessments recognise the economy’s resilience. But rising prices and interest rates will test how widely, and how durably, that growth translates into prosperity.
Across the US, Britain and Japan, governments are paying more to borrow for the long term. The IMF reports that the average interest rate on 10-year government bonds across the G7 rose by more than one percentage point between February and September, reaching its highest level in nearly two decades. These movements may seem remote from an Indian household’s concerns. Their consequences will arrive through loan repayments, employment, prices and government budgets.
Several forces are at work. Expensive energy is reviving inflation. Governments need money for defence, ageing populations, infrastructure and existing obligations. Meanwhile, enormous investments in artificial intelligence are competing for finance. Lenders are demanding greater compensation for committing their money for years, particularly when inflation and public debt make future returns less certain.
Japan adds another complication. For years, exceptionally low Japanese interest rates encouraged investors to borrow in yen and invest elsewhere, including in emerging markets. As Japanese borrowing costs rise, this strategy becomes less attractive. A strengthening yen can also make repayment more expensive. Positions built gradually can be reversed abruptly, transmitting selling pressure across countries whose underlying economic conditions may have changed little.
The AI boom is encountering its own financing test. Building data centres requires vast spending on chips, electricity, cooling and land, often well before revenues arrive. The largest technology companies have substantial earnings, but borrowing has become increasingly important across the expanding network of infrastructure providers and newer firms. Higher interest charges make uncertain future profits harder to justify.
The sharp sell-offs in South Korean technology shares this week show how quickly enthusiasm can turn into anxiety. There are fears of an AI investment bubble. The crash this week does not establish that AI’s economic promise has evaporated. They do reveal growing doubts about investment commitments and the debt supporting them. A technology can transform productivity while some of the businesses financing its expansion suffer heavy losses.
Governments face a related problem on a much larger scale. They must finance current deficits and replace loans that mature. As older, cheaper debt is replaced with more expensive borrowing, interest bills rise. Unless revenues keep pace, further borrowing follows. Global bond markets are facing intense competition for costlier funds and are feeling the squeeze from debt repayments.
India has important strengths. Its government borrows predominantly in rupees; and domestic banks, insurers and retirement funds provide a substantial investor base. This reduces dependence on foreign creditors. It also means that government borrowing draws heavily on savings held on behalf of Indian households. A dependable domestic funding base cushions external shocks. But it cannot eliminate the cost of borrowing.
The Union budget makes the vulnerability plain. Interest payments this year are estimated at approximately ₹14 lakh crore. That is nearly ₹49 out of every ₹100 of tax revenue retained by the Centre after sharing with states. Even including non-tax income, interest absorbs about 40 percent of revenue receipts. By comparison, the average for all low- to middle-income countries is 11-15 percent. India’s debt service costs are remarkably high for a country with enormous development needs. State governments face their own repayment obligations.
A rise in interest rates does not immediately reprice every government loan. Most existing bonds continue paying their contracted interest. The pressure accumulates through fresh borrowing and refinancing, gradually reducing room for schools, hospitals, infrastructure and support for vulnerable households. Strong economic growth helps by expanding revenues, but spending commitments can grow too.
India’s inflation picture has, meanwhile, changed considerably. September retail inflation reached 5.54 percent, while wholesale inflation accelerated to 11.39 percent from 9.92 percent in August, indicating substantial pressure on production costs. Businesses face rising costs even as households face higher living expenses. Companies must either absorb these costs through lower profits or pass them on to customers, risking weaker demand. The cost of expensive imported oil must still be absorbed somewhere: in oil company margins, government revenues and fiscal deficit, or eventual price increases. A weaker rupee compounds the burden.
The RBI has begun raising rates. It cannot produce more oil or repair a deficient monsoon. But it must prevent an initial supply shock from spreading into persistent inflation and weakening confidence in the currency. Higher rates abroad also make it harder to retain mobile foreign capital while keeping domestic borrowing unusually cheap.
Special measures such as the foreign currency scheme for non-residents can buy time. They cannot provide a permanent substitute for confidence and sustainable external financing. Borrowed dollars carry repayment obligations, while incentives and exchange-rate protection can impose costs. When incoming dollars are purchased by the RBI, rupee liquidity increases; absorbing it creates another policy challenge. Conversely, selling dollars to support the rupee withdraws rupees. The overall effect depends on the balance of these operations.
For households, rising prices and borrowing costs can reinforce each other. Food and fuel leave less money for other purchases. Floating-rate home loans can require higher monthly payments or longer repayment periods. Families already dependent on personal loans or revolving credit-card balances have less room to absorb setbacks. The household-debt-to-GDP ratio is at historic highs. Rising defaults are a risk to monitor, rather than grounds for declaring an inevitable banking crisis.
Nor does faster bank lending necessarily mean a new investment boom. Some companies may simply be replacing expensive bond finance with bank loans. Others need larger loans to pay higher input bills. Neither necessarily represents additional factories or jobs.
Private investment depends on expected demand, existing capacity, reliable infrastructure and predictable policy. Cheaper credit helps, especially smaller businesses, but cannot persuade a company to expand indefinitely when customers are reluctant to spend. Equally, allowing inflation to erode household purchasing power can undermine the demand on which investment depends.
There are beneficiaries of higher rates, too. Former RBI governor D Subbarao recalled meeting industrialists who always wanted lower rates. But pensioners who wanted higher ones were a silent constituency. Retirees living on deposits deserve consideration alongside borrowers. Their concern is whether interest income preserves purchasing power after inflation and tax.
India’s task is, therefore, to preserve growth while managing these competing pressures. Monetary policy needs support from credible government borrowing plans, measures to ease food and energy constraints, and targeted protection for vulnerable households. Keeping credit cheap at any cost would merely postpone the adjustment. Strong growth provides an opportunity to strengthen economic resilience before rising interest bills consume more of it.
Ajit Ranade | Economist and Senior Fellow at the Pune International Centre
(Views are personal)