Many states have debts hovering around 40%

Helped by VAT-induced incremental revenues, state governments had outperformed the Centre in fiscal consolidation for a few years till FY15, but thereafter a slippage occurred and since the onset of the pandemic, many of them have been on slippery slope. Some states with a history of large revenue deficits now have their debts hovering around a precarious level of 40% of the respective gross state domestic products (GSDPs), double the level an expert committee had found tolerable.

The aggregate debt of states reached a 15-year high of 31.3% of GDP in FY21 and is seen to be at roughly the same level in FY22. According to the respective budget estimates, states with the highest debt-GSDP ratio in FY22 are Punjab (53.3%), Rajasthan (39.8%), West Bengal (38.8%), Kerala (38.3%) and Andhra Pradesh (37.6%). All these states receive revenue deficit grants from the Centre.

In fact, twenty seven out of thirty one states and UTs saw an increase in their debt ratio by 0.5 to 7.2 percentage points on year in FY21 as the states borrowed more to fund regular expenditures as well as provide for Covid firefight, amid a sharp dip in revenues.

What exacerbated the debt-GSDP ratio was that while numerator (liabilities) rose sharply, the denominator (nominal GDP) fell sharply in FY21. The aggregate fiscal deficit of states rose to a 17-year year high of 4.2% in FY21 while nominal GDP fell by 3%.

Even in this situation, some states like Maharashtra (20%) and Gujarat (23%) maintained prudent levels of debt-GSDP ratios in FY21, as suggested by the N K Singh-led Fiscal Responsibility and Budget Management (FRBM) Committee.

According to the latest Reserve Bank of India report on state finances, Punjab topped the states with the highest debt-to-GSDP at 49.1% in FY21, 6.6 percentage points more than a year ago. This is the worst debt ratio for the state since 1991; the high debt level is the result of years of fiscal profligacy such as farm loan waivers, free electricity to large sections of consumers, among others.

As a consequence, Punjab’s annual debt servicing liability is almost the same as its annual gross borrowings, leaving little resources for asset creation. The state has consistently underperformed vis-a-vis its capital expenditure targets: it achieved just 42% of the target in FY21 and 10% in FY20.

Rajasthan’s indebtedness also deteriorated significantly in FY21 with the total liabilities of the state rising 7.2 percentage points in a year to 42.6%. The state had almost halved its debt-GDP ratio to 24% in FY15 from about 47% in FY05. One reason for the steady rise in the ratio thereafter was implementation of the UDAY scheme for power distribution entities under which the bulk of discoms’ debt got shifted to the state’s budget.

The aggregate liabilities of all states were on a declining path with debt to GDP reaching 21.7% in FY15 from 31.3% in FY05. But, it rose again consistently from FY16 after the implementation of UDAY, which was implemented by all states except Odisha, West Bengal and Delhi.

The Centre’s ballooning deficit in FY21 pushed its debt-to-GDP to also reach a 14-year high of about 59% in FY21. Given that the Centre’s debt burden is expected to scale a 16-year peak of almost 62% of GDP at the end of the current fiscal, the general government debt is seen to touch 90% of GDP, the highest after economic liberalisation in FY91.

“Any recovery in the growth rate (nominal GDP estimated to grow 17.6% in FY22) will bring down the debt-GDP ratio. If the Centre and the states adopt the kind of macroeconomic fiscal framework that they adopted in the last budget (more growth-inducing capex), the combined debt level could come down to around 80% in five years or so. It happened between FY04 and FY10,” said N R Bhanumurthy, vice-chancellor of Bengaluru Dr B R Ambedkar School of Economics University.

With growth slowing down to an average of 5.3% between FY98 and FY03 in the aftermath of the Asian financial crisis, an expansionary fiscal policy was adopted by the government that focused on infrastructure spending. High growth in this period brought down the general government debt level from the record-high levels of 83% of GDP in FY04 to around 70% in FY10.

Even though states’ debt of 20% of GDP would be a long call, bringing it down debt to 27-28% of GDP in the next few years would not be a difficult task, Bhanumurthy added.

In 2017, the FRBM panel had suggested a ceiling for general government debt (both centre and states) of 60% of GDP by FY23. And within this overall limit, a ceiling of 40% was adopted by the Centre, and 20% by the states.

Rating agency Icra on Thursday said the states’ fiscal deficit to be around 3.3% in FY22 while the Centre’s fiscal deficit could overshoot the 6.8% target owing to shortfall in disinvestment receipts and be 7.1% or therabouts. In the base scenario for FY23, it estimates the states fiscal deficit to be 3.5% and the Centre’s at 5.8%.

“Notwithstanding the lingering uncertainty, we believe that the Union Budget FY23 should ring-fence the funds that can realistically be absorbed for capital expenditure and infrastructure spending. Such outlays will help fuel the investment cycle, create employment opportunities and improve domestic demand. At the same time, rationalising of Centrally-sponsored schemes and Central sector schemes would enhance fiscal space, and further improve the quality/efficiency of expenditure,” said Icra chief economist Aditi Nayar.