Deficits of States: Trends and Implications for Resource Mobilization

The Reserve Bank of India in its “State Finances: A Study of Budgets of 2016-17” has provided a consolidated fiscal health of the states. This study has reflected the fiscal position of centre as well as states in detail for the year FY15, revised estimates for FY16 (RE) and budget estimates FY17 (BE).  A look on key data becomes essential here.

Trends of Central government

The fiscal deficit for year 2017-18 is pegged at 3.2% while the government targets 3.0% for the next financial year. The government has put more resources for Capital Expenditures with the aim to achieve fiscal consolidation without compromising the requirement of public investments. As far as revenue deficit is concerned, it is 2.1% in 2016-17 and 1.9% for 2017-18. Its marginally below the numbers proposed by amended FRBM act. Currently, the government wants to improve fiscal deficit by focussing on quality of expenditures and higher tax revenues.

Trends in State government

The fiscal condition of the states was not good for many decades. After the passing of FRBM Act in 2003, the states got extremely cautious in spending and tried to correct their finances. But in the recent years, the fiscal discipline of some states has deteriorated. According to a report by the ratings firm India Ratings and Research (Ind-Ra), aggregate fiscal deficit of Indian states will increase marginally to 3.3% of GDP  in FY’18 from its forecast of 3.2% for FY’ 17. It has also predicted that the states’ debt/GDP ratio to increase marginally to 24.3% in FY’18 from 24% forecasted for FY’17. Similarly, it expects the states’ net market borrowings as a percentage of GDP to moderate to 2.2% in FY’18 from its forecast of 2.3% for FY’17.

RBI’s Report

The RBI’s “State Finances: A Study of Budgets of 2016-17” has following key points:

Fiscal Deficit

• Most states in recent years have shown rising fiscal imbalance due to increased borrowings and increase revenue expenditures.
• For the first time in a span of 10 years, the state-level gross fiscal deficit (GFD) to GDP ratio has reached 3.6 per cent in FY16, breaching the 3% ceiling of fiscal prudence. The threshold of 3% fiscal deficit to state GDP ratio was first recommended by the 12th Finance Commission and was endorsed by both 13th and 14th Finance Commissions. The previous incident of breach in 3% of gross fiscal deficit (GFD) to GDP ratio occurred in 2004-05.
• The fiscal discipline of 20 states has declined with Rajasthan, Haryana and Uttar Pradesh clocking deficits between 5%-10%. This is due to significant capital outlays, loans and advances to power projects.
• Currently, the consolidated fiscal deficit of states is likely to remain above FRBM target in FY16 (RE) and is likely to revert to the mandated FRBM target of 3% by FY17 (BE).
• One reason for breach of the fiscal deficit target in FY16 (RE) was the borrowing of Rs 990 billion under UDAY by eight states during FY16. Excluding UDAY bonds, the fiscal deficits of the states were found to be below the mandated FRBM target of 3%.

Revenue Deficit

• Most states have stated accumulating the revenue deficits since FY14. This has increased to 0.4% in FY15 and is expected to be 0.2% of GDP in FY16 (RE). The increase in revenue deficit is due to a decline in tax revenue growth of many states and also increased revenue expenditures. The states’ own tax revenue to GDP ratio has remained stagnant at around 7.5% of GDP during the period from FY12 to FY16 (RE).
• Among the southern states, Tamil Nadu has topped the list in the parameter of revenue deficit. Kerala follows Tamil Nadu while Andhra Pradesh and Telengana have reported relatively lower revenue deficit. Karnataka is the only state that has projected a revenue surplus for 2016-17.
• According to RBI, the restoration of revenue account of states needs more focus more than the fiscal deficit.

Implication of UDAY scheme on State Finances

In November 2015, the Government had launched UDAY (Ujwal DISCOM Assurance Yojana) scheme to provide a permanent solution for financial turnaround and revival of Power Distribution companies (discoms). UDAY is basically a debt restructuring plan for discoms and a scheme of financial turnaround of state owned distribution companies.

The states which join this scheme (this implies that scheme is optional for states) would sign an MoU and will take over the 75% of Discom debts as follows:

• 50% in Financial Year 2016
• 25% in Financial Year 2017

Once the state government has taken over this debt, it would issue bonds backed by state government guarantee.

The target of UDAY is to reduce the average AT&C loss from around 22% to 15% and eliminate the gap between average revenue realized & average cost of supply by 2018-19. It will be achieved by improving operation efficiency through compulsory smart metering, upgradation of transformers, meters etc. and energy efficiency measures like efficient LED bulbs, agricultural pumps, fans & air-conditioners etc.

UDAY seeks financial turnaround and revival of discoms. UDAY attempts to shift the debt burden of discoms to state governments. Now states have to directly bear the entire cost of the subsidies on their budgets. UDAY is a comprehensive scheme as it provides measures for both cost-side efficiency and revenue-side efficiency

Implications on state finances

Ujjawal Discom Assurance Yojana has placed asymmetric impact in some states. For example, in the FY16, post-UDAY, Rajasthan’s fiscal deficit has increased more than 9% of gross state domestic product (GSDP). Interest obligations arising out of these fiscal distress alone results in large debt.

Majority of the discoms are mostly state-owned and have a large debt. The majority of this debt is with the public sector banks and financial institutions which are taken over by the state governments. It results in providing overdue settlement to the banks and improves bank balance sheet. These arrangements made under UDAY results in intra-public sector transactions.

Implications of GST

According to the report of the RBI, impact of GST on the economy and on government revenue would be significant. It has the potential to improve revenue performance of the states and support fiscal consolidation. However, all these depend upon the seamless implementation of GST.

Conclusion

As the states stand to get gains only in the medium- to long-term after the roll out of GST, it will be important for the states to remain fiscally prudent by managing their revenue account balance.