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State finances worsening
A recent RBI report on \'State Finances: A Study of Budgets,\' reveals that the combined deficit of the States reached 3.6% of GDP in 2016, which is significantly higher than 2.6% of the previous year. As per 14th Finance Commission recommendations, the debt-to-state GDP should not exceed 3%, but the combined states deficit significantly breaches the 3% fiscal deficit ceiling under fiscal prudence
A recent RBI report on 'State Finances: A Study of Budgets,' reveals that the combined deficit of the States reached 3.6% of GDP in 2016, which is significantly higher than 2.6% of the previous year. As per 14th Finance Commission recommendations, the debt-to-state GDP should not exceed 3%, but the combined states deficit significantly breaches the 3% fiscal deficit ceiling under fiscal prudence rules.
Many State governments have adopted State-level fiscal laws and adhered to the 3% fiscal target under the State-level FRBMs (Fiscal Responsibility and Budget Management Act). The debt-to-state GDP ratio of as many as 17 Indian states sharply increased in the past year. For Rajasthan the ratio stood at 10 percent, Bihar 6.9 percent, Goa 6.8 percent, Haryana 6.3 percent, Uttar Pradesh 5.6 percent, and Madhya Pradesh 3.9 percent.
It means States are borrowing money like never before, but producing not enough to pay back their debts, and as a result, their development spending which is seen at its slowest pace in 13 years this fiscal year has taken a hit. The underlying reasons for fiscal deficit could be that as a number of states have already announced farm loan waiver and more new states like Maharashtra, Madhya Pradesh and Uttar Pradesh are also looking at a similar move and it conspicuously indicates that farm loan waivers are a subset of the broader issue of issue of sustainable State finances, but loan waiver will place further financial stress on the already debt-burdened States.
Though the State governments are entitled to take such decisions but manage their financial consequences without led to sharp fiscal deterioration is the need of the hour. The Union Finance Minister recently mentioned that the Centre would not bankroll these waivers announced by the States, but this is not enough. The government should urgently focus on addressing the structural problems in agriculture.
The report noted that the fiscal consolidation of the Centre is more than offset by expansion of the States. This is due to the State power distribution companies (DISCOM) debt, 75% of which will be accounted in States’ balance sheets, and treated as capital spending in fiscal accounts. The quality of compliance by States has also deteriorated. As per fiscal laws, debt is considered sustainable if debt-GDP ratio is stable or on a declining path. This is a prerequisite for solvency of any government’s finances.
It is reportedly noted that while debt ratios for the Central government are projected to decline, the debt ratio for the States under status quo and present FRBM scenarios is projected to increase. The main reason for such scenario is that the primary deficit (total deficit excluding the interest payments) is much higher for the States compared to the Centre. According to data, primary deficit is 0.7% of GDP, while the primary deficit for states accounts close to 2% of GDP.
Nonetheless, if this picture persists, State debts will increase from close to 20% of GDP to 35% of GDP over the next 10 years. A significant consolidation by the States would be needed to keep the debt ratio stable for the States. The report also emphasis that Centre till now has shown great success in controlling fiscal deficit, which was restricted to the target of 3.5 percent of GDP in 2016-17, but the mismanagement of state finances may rob the economy of this benefit.
The state governments need to look beyond populist measures and instead focus on steps to consolidate their fiscal position. On the other hand, the Centre, instead of just shaking off the responsibility by transferring the onus to the latter, should look for options to check such fiscal extravagance by the states. If India is to grow, its states must become the champion of growth. The task of achieving macro stability must be shared by both.
Besides this a worsening of State Finances will dent India's credibility among foreign institutional investors. Moreover, the rise in government bond yield of State government securities would increase the interest burden on new debt and also for the old debt which are re-priced. Such a scenario could make State debt more explosive.
By Gudipati Rajendera Kumar
