RBI Panel Wants States To Build Larger Rainy Day Funds
Piggy banks on display. (Photographer: Ian Waldie/Bloomberg)  

RBI Panel Wants States To Build Larger Rainy Day Funds

States should hold more funds in a pool of reserves meant to ensure timely repayments on debt, recommended an advisory committee set up by the Reserve Bank of India.

The pool, known as the Consolidated Sinking Fund, should hold at least 5% of the outstanding liabilities of a state as of the previous financial year, the committee recommended. A separate fund, known as the Guarantee Redemption Fund, which acts as a backstop for any guarantees given to state enterprises should also be expanded, it said.

As of March 31, 2021, states held Rs 1.27 lakh crore in the CSF, which is close to 2.4% of the outstanding debt of states as of FY20. The guarantee fund only holds about Rs 8,405 crore. Balances in these funds earn interest at the repo rate.

The committee recommended the pool be built up over a period of five years.

The committee recommends that a minimum corpus be built by states in CSF and GRF, within the next five years, and be maintained on a rolling basis thereafter. States may build a minimum corpus of at least 5% of the total liabilities/ guarantees outstanding at the end of previous financial year.
RBI Advisory Committee

The report of the committee, which reviewed facilities such as “Ways and Means Advances” and the overdraft window available to states, was released as part of the RBI’s monthly bulletin on May 17.

Other recommendations of the committee included continuing with an expanded WMA limit for states and a longer overdraft period, which the RBI has already accepted. The limit for WMA borrowings has been set at Rs 51,560 crore till September 2021 and 21 days of consecutive overdraft are permitted.

Why Now?

The CSF was first set up in 1999 and while a number of states do hold funds in this reserve, not all do. The committee said building this buffer is in the interest of states.

Its recommendation comes at a time when state debt is on the rise, pushed higher after a year of pandemic-led borrowings.

According to an analysis by PRS India, outstanding liabilities of state governments estimated are estimated at 26.6% of gross state domestic product at the end of 2020-21. These higher obligations mean that a larger share of revenue gets spent on interest. PRS estimates that states will spend 11.7% of their revenue receipts on interest payments. The RBI sees the debt level of states as sustainable if interest payments are less than 10% of revenue receipts.

The average liabilities mask wide differences between states.

At the end of 2020-21, 18 states had liabilities more than 25% of GSDP, PRS said. “States such as Arunachal Pradesh (41.7%), Mizoram (40.9%), and Punjab (38.7%) have outstanding liabilities much higher than the average.”

The higher liabilities and larger outgo on interest payment weigh on states in tough economic years.

For instance, the committee found that at least a few states have been regularly tapping into the RBI’s Ways and Means Advances facility, which is intended for short-term cash management. Many have also been availing the overdraft facility and some are doing so more frequently. “Regular use of WMA/ OD facility indicates a persisting imbalance in the receipts and expenditure of states and requires focused attention,” the committee said.

Since April 2020, the number of states/ UTs availing WMA and the duration of utilisation of increased limits have shown a significant increase, along with an increase in the overall utilisation, due to the stressed economic situation. In the current FY 2020-21, out of the fifteen States/ UT that have availed WMA, 8 states/ UT have breached the limit and gone into OD so far.
RBI Advisory Committee

Will It Help Or Hurt?

A CSF may help protect debt repayments in times of stress.

“The Committee underscores that CSF and GRF are reserve funds, constituted voluntarily by States for a specific purpose, and need to be built up substantially,” the report said. “Hence, the Committee urges the remaining States to join CSF/ GRF schemes, which would facilitate them to withdraw from the Fund to repay liabilities in times of need...”

The committee argued:

  • The CSF can act as a buffer fund for repayment of redemption dues.
  • Availability of a buffer fund increases the investors’ confidence in state borrowings and could bring down the cost of funds.

Historically, however, states have not seen many benefits to the fund.

The key concern for many states is they borrow from the market and set aside funds since most run a revenue deficit. As such, borrowing limits get utilised to put money away in this sinking fund. Also, these funds, until now, get locked in for a period of five years and states can’t withdraw the principal amount.

To counter these concerns, the committee suggests that the lock-in period of these funds be reduced to two years. States can also be allowed to the interest accrued for repayment of outstanding liabilities. In addition, states can continue to borrow against these funds at a rate 2% below the prevailing repo rate from the RBI’s ‘Special Drawing Facility’.

Not everyone sees merit in a larger reserve pool.

Govinda Rao, a member of the 14th Finance Commission, said there is merit in the idea of creating a buffer but the question is where that buffer is coming from. If a state is running a revenue deficit, it will be borrowing to put money in a reserve fund. That, according to Rao, counters common sense. “You borrow more to transfer funds to this reserve. What’s the purpose?”

Madan Sabnavis, the chief economist of CARE Ratings, also had some concerns. While the fund is a useful backstop, maintaining 5% of outstanding liabilities in it seems large, he said. It’s a losing proposition for states to borrow from the market and put money in the fund which earns a lower return, he said. Also, since borrowing limits for states are fixed, this will take away from funds they can raise for regular budget use.

Sabnavis said from the central bank’s perspective the idea is to introduce greater prudence in state finances and that is understandable. “But the reality is states have never been allowed to default and a larger fund may not be something that will put to use.”

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