State Finances Deteriorated In FY17 But Remain Sustainable, Says RBI
The current fiscal policies of states are sustainable in the long run, said the RBI in its report on state finances.
State finances worsened in financial year 2016-17 in contrast to an expected improvement over the previous year, the Reserve Bank of India (RBI) observed in its study of state budgets, released on Friday. Their financial condition, however, remains sustainable and states are expected to continue their efforts towards fiscal consolidation in 2017-18, the RBI said.
The deterioration in state finances started in 2015-16. For the first time in more than 10 years, the Gross Fiscal Deficit-Gross Domestic Product (GFD-GDP) ratio hit 3.6 percent, crossing the threshold of 3 percent. This was mainly due to a significant increase in capital outlay and loans and advances to power projects.
In 2016-17, states were expected to improve their fiscal health but it hasn’t played out that way, shows the RBI report.
Although states projected for an improvement in the consolidated GFD-GDP ratio in 2016-17, information available for 25 states reveals a slippage of 0.4 percent of GDP from budgeted estimates. States, however, are expected to continue their efforts towards fiscal consolidation.RBI Report On State Finances
Based on information available for 25 states, the GFD-GSDP ratio is budgeted at 2.6 percent in 2017-18, as compared to the revised estimate of 3.4 percent for 2016-17. There are several downside risks to the projections for the current year, the RBI cautioned. These include the implementation of recommendations of states’ own pay commissions, farm loan waiver in some states, and revenue uncertainty on account of the implementation of the Goods and Services Tax (GST).
Expected Impact of GST
While the RBI report noted that there could be some revenue uncertainty on account of the implementation of GST, it added that the immediate impact is expected to be negligible since the GST structure emphasises a revenue-neutral rate.
In the long term, the impact of GST is expected to be positive, said the RBI citing estimates from rating agency CRISIL.
In the medium to long term, however, GST is likely to increase the tax buoyancy of the Central and state governments by 0.6 percent which is likely to reduce the gross fiscal deficit by 0.7-1.2 percent of GDP if disinvestment receipts and non-tax revenues remain unchanged from the trend of the previous five years.
The report said the macroeconomic impact of the introduction of GST could turn out to be significant in the years ahead, given the dominance of the services sector in India.
Besides giving a major boost to tax revenue, the larger impact on the fiscal health would be from reduction in the administrative compliance cost. GST is likely to be supportive of fiscal consolidation without compromising capital expenditure.RBI Report On State Finances
Cautioning Against Farm Loan Waiver
The central bank once again raised a red flag against the impact of farm loan waivers. Such waivers could add to the fiscal burden of states and affect their finances over the medium term, said the RBI.
While these loan waivers could alleviate the immediate debt burden of financially distressed farmers, it is essentially a transfer from taxpayers to borrowers with an adverse bearing on the fiscal viability of states. Moreover, it impacts credit discipline, vitiates credit culture and disincentivises borrowers from repayment, thus engendering moral hazard with expectations of future bailouts.RBI Report On State Finances
Further, if overall government borrowings increase due to the issuance of debt relief bonds by state governments, yields on state development loans (SDL) may rise, the RBI cautioned. “Concomitantly, it can also crowd out private borrowers, given the finite pool of investible resources in the economy,” said the RBI.
As per RBI records, gross market borrowing of states was at Rs 3.8 lakh crore in 2016-17 – comprising around 85 percent of GFD. Borrowings increased by 29.7 percent over the previous year, the report said.
The combined gross market borrowings of the Centre and the states increased by 7.1 percent during 2016-17.
“The increasing reliance on market borrowing could pose a challenge for the sustainability of state finances as higher state borrowings raise yields and the cost of borrowing,” said the report.
Impact Of UDAY Scheme
One reason for a deterioration in the state’s reported finances has been the UDAY scheme, under which states have converted part of the debt held by state power distribution companies (DISCOMS) into state government bonds. While most of the impact of this was felt in 2015-16, some spilled over into the just-concluded financial year.
Under the scheme, states took over 75 percent of Discom debt as on September 30, 2015 over two years – 50 percent in 2015-16 and 25 percent in 2016-17.
As per the RBI records, eight states borrowed Rs 98,960 crore under UDAY during 2015-16. Excluding these borrowings. the GFD-GDP ratio would have stood at 2.9 percent compared to the reported 3.6 percent for 2015-16.
Notwithstanding the deterioration of the debt position of state governments in the preceding two years due to their participation in the financial and operational restructuring of state power distribution companies through UDAY, empirical evaluation reveals that the current fiscal policies of states are sustainable in the long run.RBI Report On State Finances