Additional Borrowing Limits for Sates

The Union Cabinet chaired by Prime Minister Narendra Modi has given approval to the recommendations of Fourteenth Finance Commission (FFC) on fiscal deficit targets and additional fiscal deficit to States during 2015-20. From now on, the States committing to greater fiscal discipline have been allowed to relax the existing cap on fiscal deficit of 3% of the gross state domestic product (GSDP) to a maximum of 0.5%.

Why such a move has been taken?

The fiscal deficit threshold limit of 3 per cent of Gross State Domestic Product (GSDP) for the States was restricting them from carrying out capital expansion activities. Imposition of such a condition was a disincentive to the best-performing states. The combined borrowing of state governments for 2014-15, was Rs.2.4 trillion.

Now the states will get additional headroom to raise borrowings to cater to their development needs based upon their current macro-economic requirements. It will also incentivize states to adopt fiscal discipline and prioritize their development spending.

Which states are eligible?

It has been provided that only those states that have a debt-GSDP ratio of less than 25% and interest payments-revenue receipts ratio less than 10% in the previous two years are eligible to raise their fiscal deficits to a maximum of 0.5 per cent over and above the normal limit of 3 per cent in any given year. Out of the two conditions, if a state fulfils only one condition, then it will be eligible to increase borrowing by a 0.25% above the 3% of GSDP limit. Further, the flexibility in availing the additional fiscal deficit can be availed by a State only if there is no revenue deficit in the year in which borrowing limits are to be fixed and immediately preceding year. The changes will be valid from 2016-17 till 2019-2020. In case a state is not able to fully utilize its sanctioned fiscal deficit of 3% of GSDP in any particular year from 2016-17 to 2018-19, then the provisions allows the state to carry it over to the next year.

Which states stand to be benefitted?

The Care ratings in its analysis of state budgets has showed States like chattisgarh, Madhya Pradesh, Jharkhand, Odisha and Telangana has less than 10% interest payments to revenue receipts ratio and therefore are eligible for raising their fiscal deficit to 3.25% of GSDP. On the other hand, states like Andhra Pradesh, Gujarat, Kerala, Punjab, Rajasthan, West Bengal, Goa, Maharashtra, Haryana and Uttarakhand will not be eligible.

What are the implications?

• There will not be any financial implication on the central government as the borrowings are made within the fiscal deficit limits by the respective states, as laid down by Finance Commission and incorporated in FRBMA of the states.
• The provision of carry forward any unutilized fiscal deficit amount will allow states to flexibly time their borrowings in tune with foreseeable expenditure spikes like pay commission awards. This is far better than the States’ current practice of exhausting borrowing limits each fiscal year irrespective of the actual need and investing the excess funds in low interest bearing Treasury Bills.
• Debts of the states may rise and the increase in borrowings will mean states will have to pay higher price to attract buyers. Market borrowings will rise in the current fiscal year on account of low revenue buoyancy, higher wages for states’ employees in tune with 7th pay commission’s recommendations, and the need to provide interest payments on UDAY(Ujwal Discom Assurance Yojana) bonds.
• According to the economists, although the additional borrowing space will act as an incentive for the states to incur expenditure for actual needs, in the short term, however, the states will have to cut capital expenditure or look for additional options to raise revenue due to the constraints imposed for raising revenues coupled with the pressure of implementing the 7^th pay commission awards.

What is the way forward?

The government needs to implement GST (Goods and Services Tax) to increase the revenue buoyancy in the long term without which the states may not be in a position to meet their fiscal targets without resorting to expenditure cuts.