The Financial State Of India’s StatesBloombergQuintOpinion
India’s central government has recently decided to borrow an additional sum of Rs 1.1 lakh crore from the bond market and pass it on to states in lieu of meeting the shortfall related to the GST compensation cess. One of the reasons why this arrangement was finally decided upon, was to avoid differential rates of interest that individual states would have been charged for their respective State Development Loans under the alternative options and given that this will be easier to manage administratively. In a separate development, the Reserve Bank of India announced that it will conduct its first-ever open market operation purchase of SDLs on Oct. 22 for Rs 10,000 crore, which will include securities of 15 states like Maharashtra, Karnataka, Gujarat, Bihar, Madhya Pradesh, Kerala, to name a few.
The adverse impact of Covid-19 on the centre’s fiscal dynamic is well tracked, but not enough focus is accorded to scrutinise states’ finances. In fact, given that the market borrowing needs of states have increased significantly in recent years due to the change in the financing pattern of their deficits, it is even more important now to follow the state finances closely.
Fiscal Ranking Of States
A ranking of India’s key states based on their relative fiscal performance is constructed with the use of three fiscal parameters: fiscal deficit; own tax revenue; and state debt; all as a percentage of gross state domestic product. The analysis is restricted to seventeen key states, and offers investors looking to invest in SDLs a detailed disaggregated view.
As per this analysis, Maharashtra tops the fiscal scorecard followed by Chhattisgarh, Odisha, Karnataka, and Uttar Pradesh based on the FY19 actual fiscal data.
At the bottom end of the spectrum are states such as Rajasthan, Punjab, West Bengal, Andhra Pradesh, Bihar, and Kerala.
Some states such as Punjab have seen a sharp increase in debt-to-GSDP during the last few years (40.6% in FY19) relative to the combined average of 25.2% in FY19 of the 17 states used in our analysis. Other states such as West Bengal are already saddled with high debt (34.8%) due to legacy issues, leading to a lower ranking. Uttar Pradesh, on the other hand, suffers from high debt (30.2% of GSDP) relative to the combined average but ranks better overall due to a high own tax revenue collection (8.1% of GSDP) versus West Bengal’s 5.4% and overall average of 6.4%. Bihar and Rajasthan are also states that are traditionally fiscally-challenged, with the power sector debt-restructuring scheme, Ujwal Discom Assurance Yojana, exacerbating their fiscal woes, particularly in case of the latter.
Trends In States’ Borrowing During H1FY21
The total cumulative market borrowing of 30 states between April and September of 2020 has already increased by 51% from the corresponding period of the previous year. States like Karnataka (+476% YoY), Maharashtra (+204% YoY), and Tamil Nadu (+116% YoY) account for a bulk of the increase. These three states, which were responsible for 36% of the total market borrowing between April and September 2020, also account for 41% of total Covid-19 cases (Maharashtra at 21.3%, Tamil Nadu at 9.2%, Karnataka at 10.1%) in the country and contribute 31% to India’s national GDP.
It is not surprising that states that have been affected the most due to the pandemic are also those which have increased market borrowing more significantly than others.
Unfortunately, these three states also happen to be the most economically important states, each contributing at least 8% to India’s national GDP. Maharashtra alone contributes 14.5% to India’s GDP, followed by Tamil Nadu and Karnataka at 8.6% and 8.0% respectively.
There are two more economically important states – Gujarat and Uttar Pradesh – which contribute 8.4% and 8.1% respectively to India’s national GDP.
Uttar Pradesh—the most populous state of India—has had 6.1% of total Covid-19 cases in the country but has seen its market borrowing from April to September decrease by 41% YoY. This seems odd, but a plausible explanation can be found in the fact that Uttar Pradesh accounts for the highest own-tax-revenue among all the states, at over 8% of GSDP.
Gujarat, on the other hand, which is responsible for 2.1% of total Covid-19 cases has increased its borrowing by 12% YoY in the first half of FY21. Unlike Uttar Pradesh, Gujarat’s OTR collection is significantly lower at 5.3% of GSDP, resulting in the need to increase market borrowing. That said, the extent of the increase has been quite low, which may have to do with the fact that Gujarat has historically always tried to maintain its fiscal deficit at lower levels, relative to other states.
Punjab had the highest debt-to-GSDP among states at 40.6% even before Covid-19 which has likely constrained its market borrowing – down 13% YoY in April-September 2020. Meanwhile, relatively fiscally prudent states such as Maharashtra, Karnataka, and Chhattisgarh have been able to increase their borrowing in the midst of the Covid-19 pandemic.
Which States Are Relatively More Vulnerable To Debt Sustainability Risks?
A recent RBI working paper, published on July 2, titled "Subnational Government Debt Sustainability in India: An Empirical Analysis", concluded that “states’ debt is just about sustainable with some signs of unsustainability likely to emerge.” The study listed the quantum of guarantees given by states over the years and incorporated these guarantees to arrive at an augmented figure of combined state debt, which is the true debt obligation at the subnational level. The paper concluded that “guarantees given by states, if invoked, could certainly pose a potential risk to debt sustainability for Indian states.”
Unfortunately, the paper does not cover the Covid-19 pandemic period and its impact on state finances. The analysis covers data only up to 2017-18, beyond which the state fiscal dynamic has deteriorated further.
What is particularly worrying is that even with data till 2017-18, the conclusion of the report is that states’ debt sustainability is at risk.
Surely, a severe shock like the Covid-19 pandemic is bound to have an extremely negative impact on the debt-to-GSDP position of the state government.
We estimate how much the combined state debt-to-GDP is likely to have deteriorated in FY21 and the likely trajectory thereafter. We assume that the combined states' fiscal deficit will increase to 4.5-5.0% of GDP in FY21 and then moderate slowly to 3.5% of GDP by FY23. Under these assumptions, we estimate state debt-to-GDP to increase to almost 29% in FY21, from about 24.6% in FY20 and 22.9% in FY19. This is then expected to moderate to about 28% by FY23, as growth starts to normalise from the next fiscal year. This is significantly worse than the FRBM target which recommended state debt-to-GDP to be maintained at 20% of GDP till FY25.
As per RBI data, overall state guarantees amounted to about 2.5% of GDP by 2018. The guarantees will likely increase more in FY21 due to the adverse impact posed by the Covid-19 pandemic. Assuming some of these guarantees get invoked, states’ debt-to-GDP could easily rise above 30% of GDP, from about 23% average before FY20. The states which will remain the most vulnerable to debt sustainability risks are Punjab, West Bengal, Rajasthan, Bihar, Andhra Pradesh, and Kerala, given their weak fiscal and debt metrics even before Covid-19 crisis.
Kaushik Das is India Chief Economist at Deutsche Bank AG.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.