States’ Fiscal Deficit Rises Most In 12 Years Due To Higher Capital Expenditure

The states’ fiscal deficit in the financial year 2015-16 (revised estimate, RE) as a percent of gross domestic product (GDP) rose to the highest since financial year 2003-04, however expansion of state budgets have been mainly on account of capital expenditure, which is a long-term credit positive for states, says India Ratings and Research.

For FY16 the consolidated fiscal deficit to GDP would have been 0.7 percent lower excluding Ujjwal Discom Awas Yojana (UDAY). Ind-Ra had highlighted the impact that UDAY will have on states’ deficit in the report UDAY Unlikely to Destabilise Aggregate State Finances but Select States Will Feel the Pinch.

Investors have been raising concerns lately on the increasing fiscal deficit of the state governments. According to the latest RBI’s publication “State Finances A Study of Budgets of 2016-17”, shows that the combined fiscal deficit of the states in FY16 (RE) has increased to 3.6 percent of GDP, highest since FY04 (4.2 percent of GDP).

The combined fiscal deficit of the states’ have been showing an increasing trend since FY12 (Fiscal Deficit: 1.2 percent of GSDP). Fiscal deficit can be decomposed in two parts – revenue deficit and capital expenditure net of capital receipts.

Between FY12 and FY16 (RE), combined fiscal deficit of the states’ increased by 1.7 percentage points of GDP. While there was a reversal in the trend of the combined revenue account of the states’ from a surplus of 0.3 percent of GDP in FY12 to a deficit of 0.2 percent of GDP in FY16 (RE), which added 0.5 percentage point of GDP to fiscal deficit, an increase in the combined capital expenditure of states’ added 1.0 percentage point of GDP to the fiscal deficit during the same period. The average growth of states’ aggregate capital expenditure during FY12-FY16 (RE) was 23.7 percent.

As against the Union government’s capital expenditure which has remained less than 2 percent of GDP since FY12, the states’ combined capital expenditure/GDP ratio has remained over 2 percent since then. Another noteworthy feature of state finances has been the restrain shown by the states in spending the higher devolution received due to the recommendation of the fourteenth finance commission. The fear was that the states’ will use higher devolution to enlarge their budget mainly via current expenditure.

However, the data suggests that expansion of state budgets have taken place mainly on account of capital expenditure, which is a long-term credit positive for states.

India Ratings and Research, a wholly owned subsidiary of Fitch Group, is a SEBI and RBI accredited credit rating agency operating in the Indian credit market.