RBI’s recent report on “State Finances” has pointed out the rising fiscal deficits for state governments.
Sadly, the situation is unlikely to improve in the near term though revenue receipts are projected to go up in 2018-19.
What does the RBI report state?
Gross Fiscal Deficit
Populist schemes, escalating pay revisions, and farm loan waivers have limited the state governments’ ability to contain expenditures.
Due to heavy borrowings and consequent unsustainable interest burdens, indebtedness of states is rising and it is crowding out capital expenditure.
Inefficient tax collection (a pan Indian phenomenon), and the inability of States to rein in fiscal deficit has risen to epic proportions.
2017-18 is the 3rd consecutive year during which States were unable to contain their Gross Fiscal Deficit (GFD) within 3.0% limit.
Notably, the 3% limit is a legal mandate that most states have pledged to under their “Fiscal Responsibility and Budget Management” target.
GST Impact
The 0.33% shrinkage in State’s “own tax revenues” (OTR) in 2017-18 vis-à-vis the Budget estimate is due to accounting issues related to GST.
Most States have reported State GST revenue, but reporting of Integrated GST, Central GST, and GST compensation cess has not been consistent.
While an accurate assessment of 2017-18 OTR will be available only in 2018-19, the shortfall was partially offset by greater devolution from the centre.
Salary Expenditures
The aggregate work force of State governments exceeds that of the Union government and the salary expenditure is a big burden for them.
13th Finance Commission (FC) had recommended that the ratio of “salary expenditure to overall revenue expenditure” should not exceed 35%.
But most states don’t adhere to it and some have fared as high as 55% after the pay commission revisions were implemented.
Borrowing Costs
Despite interest payments increasing by almost 16% over 2016-17 in 2017-18 (RE), the ratio of interest payments to GDP was stable at 1.7%.
However, the weighted average yield on state government debt, increased from 7.48% in 2016-17 inched up to 7.60% in 2017-18.
Notably, state government’s bonds attract a premium over the Central government’s bonds, thereby making borrowing costly.
Food Subsidy
The Centre footed around 85% of the food subsidy bill during 2015-18, but States play a vital role in food security by distributing subsidised food grains.
Subsidies - During 2015-16 to 2017-18, many state governments subsidised food grains further from the central issue price up to 0.4%.
Significantly, three States (Tamil Nadu, Karnataka and Kerala) distribute them for free to all “Antyodaya Anna Yojana” and priority household cardholders.
Unsurprisingly, 2017-18 State subsidy bill on food grains was maximum for Tamil Nadu (Rs. 2,000 crore), followed by Karnataka (Rs. 1,000 crore).
DBT - Direct benefit transfers (DBT) of food subsidies through cash transfers reduce the need for large physical movement of food grains.
Further, it is also desirable as it would provide greater autonomy for beneficiaries to choose their consumption basket.
But the switch to DBT requires the fulfilment of certain pre-conditions, which including complete digitisation and de-duplication of the beneficiary database.
Also, Aadhaar seeding of bank accounts and ensuring adequate availability of food grains in the open market are other complications.
Redemption Pressures
Most States (barring Delhi, Madhya Pradesh, Kerala, and Arunachal Pradesh) are currently excluded from the National Small Savings (NSS) Fund facility.
This has increased redemption pressure (account closures without access to new cheap funds from NSS) on state governments.
Notably, market borrowings of states more than doubled in the past 5 years Rs. 30,630 crore in 2012-13 to Rs. 78,900 crore in 2017-18.
Further, states are expected to face maximum redemption pressure in 2026-27, when over Rs. 3,50,000 crore State development loans (SDL) are due.
Capital Expenditure Impact
The inability of State governments to rein in their revenue expenditures has resulted in a crowding out of capital expenditures.
Capital expenditures continued to be abysmally low despite marginally improving to 2.8% of GDP in 2017-18 (RE) from 2.6% in 2016-17.
Unbudgeted pre-election expenditure in some states and implementation of remaining pay commission awards is only likely to weaken the fiscal further.
Currently, there is minimal difference between the yields of debt issued by States with stronger and weaker fiscal profiles.
The RBI has recommended States to secure fiscal ratings, so as to make states eligible of capitalising on loans according to their stature.
