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State governments and debt

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State governments, it appears, are doing better than the Union government, when it comes to managing their fiscal house. The moot question remains: How much better? And how will the proposed Goods and Services Tax affect state finances?

STATES’ FISCAL POSITION

The states’ revenue deficits decreased from 0.4% of GSDP to 0.2% in FY 2016, compared to FY 2015. While both revenue receipts and expenditures increased, the former rose more than the latter, leading to reduced revenue deficits. While states’ own tax and non-tax revenue receipts went up marginally, the improved performance was mainly on account of the enhanced central transfers, in particular the devolution of higher proportion of taxes of 42% (from the earlier 32%) from the divisible pool of taxes as recommended by the 14th Finance Commission. While the revenue expenditure went up, the states were able to keep interest payment increases in check. Thus, the interest expenditure component went up by a mere 0.1%.


The Gross Fiscal Deficit position of the states, however, was not encouraging. In fact, the GFD to GSDP ratio deteriorated by 1% – from 2.6% to 3.6% over the period 2015-16. In doing so, it breached the fiscal prudence limits of 3% set by successive Finance Commissions since the Twelfth Finance Commission, and acknowledged by the state governments in their Fiscal Responsibility and Budget Management Acts. It was also the first time since 2004-05 that this limit had been breached.

The states’ fiscal deficit had been higher on account of both revenue and capital expenditure increases. Capital expenditure went up by 1%, with developmental expenditure going up more than non-developmental expenditure. The governments’ intent to create growth-enabling infrastructure was seen in the areas of capital outlay, viz. major and medium irrigation and flood control, energy, and roads and bridges. However, the increase in capital expendiure was also on account of an increase in loans and advances for power projects under the Ujwal Discom Assurance Yojana Scheme (UDAY). The bulk of revenue ependiture was also for developmental purposes, such as education, sports, social security and welfare, rather than the non-developmental pensions, interest payments and administrative expenses.

The Primary Deficit (i.e. Fiscal Deficit net of interest payments) had also deteriorated from 1.1% of GDP to 2% of the GDP. Thus, state governments have been adding more to the deficits through their current year activities alone, other than for meeting interest expenses. This would lead to larger fiscal deficits in the future, and indicates fiscal irresponsibility.

The aggregate analysis, however, presents a far rosier picture of state finances than actually exist. A disaggregated analysis reveals that the situation in 11 of the 29 states, called special category states, is far more worrisome. In these states, the Revenue Deficit-GDP ratio actually changed from a surplus of 0.3% to a deficit of 0.3% over the past fiscal year. However, the RD-GDP ratio also worsened in 11 of the 18 non-special category states.  The GFD-GDSP ratio almost doubled from 3.5% in FY 2015 to 6.1% in the special category states in FY 2016, while the Primary Deficit rose from 1.5% to 4% of GDP. However, there were other non-special category states, which also witnessed a worsening of the GFD position, with 20 states in all exhibiting a negative trend. 14 of the 18 non-special category states witnessed a worsening of the primary deficit position, with states like Rajasthan exhibiting a worsening of the primary deficit from 1.4% to 8.2% of GDP.

STATE DEBTS

The outstanding liabilities of state governments grew by 17.4% in 2016, compared to 9.4% in 2015. The debt-GDP ratio increased from 21.7% of GDP in 2015 to 23.2% of GDP in 2016. State- wise data revealed that the debt-GSDP ratio increased for 17 states. Such debt liabilities can cause problems for macroeconomic and fiscal stability.

An assessment of debt sustainability indicates that the rate of growth of debt at the aggregate level for all states has been higher than the nominal rate of growth in the economy in the 2012-13 to 2015-16 period. However, the real growth of the economy was higher than the real interest rate during this period, indicating sustainability of primary deficit. Looking at the conditions for assessing the debt sustainability, both the primary balance to GDP ratio and the primary revenue balance to GDP ratio, were negative. As such, they indicate a not-so-comfortable position in terms of debt sustainability.

GST AND STATE FINANCES

The introduction of the Goods & Services Tax will pose both opportunities and challenges, given the current state of state government finances. The prevailing uncertainty about the revenue outcome from the GST implementation could cause the outlook for revenue receipts of states to turn uncertain. There is, however, the cushion of compensation by the Centre for any loss of revenue for the initial five years. While the long run outlook remains positive, individual state governments will need to increase their own competitiveness over a period of time in order to ensure fiscal sustainability.

 

The author is Professor of Economics at the S.P. Jain Institute

of Management & Research, Mumbai. Views are personal.