By: Nivriti Rathi, Research Analyst, GSDN
Fiat money is a government-issued currency that is not backed by a physical commodity like gold or silver. It is a legal tender whose value depends on the issuing country’s economic stability. Its value is maintained through regulation by central banks, which control the money supply and influence factors such as inflation, interest rates, and overall economic stability. Unlike commodity-backed currencies, fiat money allows governments greater flexibility in responding to economic changes, although mismanagement can lead to inflation or currency devaluation. It is widely used across the world, including currencies like the US dollar, Euro, and the Indian Rupee. It supports global trade, financial systems, and digital payment ecosystems, enabling seamless transactions in modern economies. While fiat currency has its numerous benefits, there are quite some disadvantages too. Excessive money printing or poor policy decisions can reduce purchasing power and lead to high inflation. It has no intrinsic value, so its worth depends entirely on public confidence in the issuing authority. In the case of the Indian Rupee, it is issued by the Reserve Bank of India. Also, the country’s currency value can fall due to trade imbalances, or loss of investor confidence.
This is where fiat currency relates with public national debt. Legal tender provides fiat money with the legal force it needs if it is to be mandated as the means of extinguishing debt in a given jurisdiction. Contemporary fiat money represents the end of a long process of development whereby governments have used their power of legal tender to use money to pursue various policy goals. Prior to the introduction of paper money, governments were more than willing to debase gold and silver coinage to artificially reduce their debts. Adam Smith pointed out in his Wealth of Nations (1776) that “when national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid.” Smith then added that “the liberation of the public revenue, if it has ever been brought about all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.”
A major problem of fiat money concerns the way that it encourages the illusion that governments and central banks can somehow “manage” multi-trillion dollar economies. The international obligations accepted by all countries adhering to the gold standard (even in its debased post-World War I forms) placed some limits on governments’ capacity to use their legal tender powers to pursue any number of macroeconomic objectives. With fiat money, however, any such restrictions are removed. Instead government and central bank officials can increase or decrease the money supply as they see fit in response to any number of economic phenomena. Sometimes it works, but it also often fails. In other words, the state’s efforts to manage fiat money means that monetary policy is far more dependent on the decisions of fallible human beings who cannot possibly know all the consequences of their choices, rather than the functioning of the rules of something like the gold standard, which, for all its imperfections, provided more predictability about the economy’s likely direction.
Now, fiat currency contributes to national debt because modern money is fundamentally created through the issuance of government debt. How does this process work? The first step is the issuing of bonds. When a government needs to spend more money than the amount estimated in the budget, its treasury issues securities like government bonds, notes, and bills. A central bank then buys these bonds, effectively ‘fiatting’ new digital or physical currency into existence to pay for them. Because the newly created money enters circulation in exchange for these government bonds, every dollar of base fiat money corresponds to an obligation that the government or its central bank formally track as public debt. Countries borrow from each other or from global organizations like the World Bank and the International Monetary Fund (IMF). But why does the system encourage more debts? This is because governments do not need to mine a scarce commodity to spend, they can run continuous budget deficits by borrowing more against future tax revenues. Public national debt is the total amount of money a government owes to its creditors because its spending exceeds its tax revenues over time. This happens when the budget is deficit. Major entitlements like social security, medicare, and public healthcare demand continuous, high levels of funding. Large military budgets and necessary long-term investments in public works require upfront capital that exceeds regular tax intake.
Recessions reduce tax collections because citizens and businesses earn less money. Governments deliberately increase borrowing during major crises, such as the Great Recession or the COVID-19 pandemic, to stabilize the economy and support citizens. When businesses close and people lose jobs, spending drops. Government borrowing funds relief checks, unemployment benefits, and public projects. This keeps money moving in the market. Without government intervention, a sharp drop in spending can trigger a severe economic depression. Pumping borrowed money into the system cushions the fall and helps the economy recover faster. During such downturns, central banks often lower interest rates. This makes borrowing very cheap for governments, reducing the cost of managing the new debt. Governments send direct payments or tax cuts to households. People spend this money on food and rent, which keeps local stores and companies alive. Loans and grants are given to vital industries like airlines or small businesses to stop massive bankruptcies and mass layoffs.
But governments also raise money by selling bonds, often to institutional investors or pension funds. An investor buying a bond is lending the government money for an agreed term, and many bonds pay out interest at regular intervals known as coupon payments. When the agreed term of a bond ends known as its maturity date, the government pays back the original sum of money. Some bonds are very short term, others last for decades. More than half the world’s governments have defaulted since 1960, according to a database run by the Bank of Canada and the Bank of England. So investors have to take the risk of default seriously. If an individual or a company doesn’t pay back a loan, creditors can take legal action and go after the defaulter’s assets. Economists are divided over how much borrowing countries can afford. Traditionally, they become alarmed if a state’s debt is high in relation to its gross domestic product (GDP). But many countries borrowed far more than they planned in the pandemic. The European Union, for example, relaxed rules which limit debt to 60% of economic output.
As of May 29, 2026, according to the RBI’s annual report about Public Debt Management, the Central Government’s Gross Market Borrowings are US$ 152.77 billion, whereas the Net Market Borrowings lie at an approximate of US$ 113.5 billion. Currently, India’s debt to GDP ratio is 81.92%. The central government debt is 53.83% and the general government debt is 81.29%. This means that the national central government debt is US$ 2.02 trillion and the national central government debt per capita is US$ 1,395.01.
While presenting the Union Budget 2026-27 in Parliament on February 1, 2026, Union Minister for Finance and Corporate Affairs, Smt. Nirmala Sitharaman stated, “Government has been delivering on fiscal commitments consistently without compromising on social needs.” In line with this, the debt-to-GDP ratio is estimated to be 55.6 percent of GDP in Budget Estimates 2026-27, compared to 56.1 percent of GDP in Revenue Estimates 2025-26. A declining debt-to-GDP ratio will gradually free up resources for priority sector expenditure by reducing the outgo on interest payments. While speaking about Fiscal deficit, one of the main operational instruments for debt targeting, Smt. Sitharaman informed the parliament that the commitment made in FY 2021-22 to reduce the fiscal deficit below 4.5 percent of GDP by 2025-26 has been fulfilled. In RE 2025-26, the fiscal deficit has been estimated at par with BE of 2025-26 at 4.4 percent of GDP. In line with the new fiscal prudence path of debt consolidation, the fiscal deficit in BE 2026-27 is estimated to be 4.3 percent of GDP. The Finance Minister informed that, “The RE of the non-debt receipts are ₹34 lakh crore of which the Centre’s net tax receipts are US$ 279.5 billion. The Revised Estimate of the total expenditure is US$ 521.3 billion, of which the capital expenditure is about US$ 115.1 billion. The non-debt receipts and the total expenditure are estimated as US$ 383.61 billion and US$ 560.68 billion respectively. The Centre’s net tax receipts are estimated at US$ 301.35 billion. To finance the fiscal deficit, the net market borrowings from dated securities are estimated at US$ 122.97 billion. The balance financing is expected to come from small savings and other sources. The gross market borrowings are estimated at US$ 180.72 billion.”
Future generations pay back the costs of today’s spending. “Over the next few years, as many as a dozen developing economies could prove unable to service their debt,” says Marcello Estevão, Global Director, Macroeconomics, Trade and Investment at the World Bank, “the largest spate of debt crises in developing countries in a generation.” Even in wealthy countries, the current levels of government debt are potentially unfair on future generations whose taxes will be used to pay back money borrowed to pay for today’s public spending. That will be more manageable if economics grow, but there is a danger some governments will find paying the interest on their debt cuts into the money they have available to invest in projects which could have helped with development. High government debt isn’t the only concern. The amount of money owed by private businesses and individuals is also surging in some countries, pushing global debt to new heights. That has prompted the International Monetary Fund to warn that governments need to act together to tackle spiraling borrowing and safeguard security and prosperity across the world.
India can improve its national debt and lower its debt-to-GDP ratio by combining strict fiscal consolidation, spending rationalization, and sustainable economic growth. India needs to adopt a declining debt-to-GDP ratio as the primary fiscal target, aiming to bring central government debt down significantly over the next few years. We can cut wasteful consumption expenditures and curb subsidy misuses, such as tightening digital verification for LPG or food schemes) while protecting high-multiplier capital investments. Leverage artificial intelligence and technology integration, such as cross-matching Goods and Services Tax (GST) and income tax returns to widen the tax base and reduce evasion. Using active bond-switching mechanisms to replace short-duration sovereign papers with long-duration bonds can smooth out repayment schedules and mitigate rollover risks. And lastly, foster high economic growth and job creation in manufacturing and infrastructure. A rising nominal GDP naturally shrinks the relative size of the debt burden over time.
