Why state finances are important

The Indian fiscal landscape has been transforming over the last decade. The state governments are now responsible for a considerable share of total government spending and borrowings. Therefore, policymakers and the bond markets have increased their focus on whether the states can improve the quality of their expenditure, maintain prudent fiscal deficits and reduce their debt levels. The surge in planned state government market borrowings in the first quarter of 2018-19 has dampened the cheer that was wrought by the budgeted decline in the states’ fiscal deficit and improvement in the quality of their expenditure in 2018-19.

 

The aggregate fiscal deficit of India’s state governments escalated to Rs 4.8 trillion in 2016-17, from Rs 2 trillion in 2012-13. In contrast, the Union government’s fiscal deficit rose mildly to Rs 5.3 trillion in 2016-17, from Rs 4.9 trillion in 2012-13, while continuing to exceed that of the states. State development loans (SDLs), which are issued by the state governments, have emerged as the primary tool for financing their fiscal deficits. The share of fresh SDLs in the combined market borrowing of the states and the Union government rose rapidly to 41.6 per cent in 2017-18, from 24.1 per cent in 2012-13. The indicative borrowing calendars released by the Reserve Bank of India (RBI) on behalf of the central and state governments signal that this metric is set to climb further to around 46 per cent in the first quarter of 2018-19, enhancing the importance of the evolving fiscal health of the states for the bond markets.

 

ICRA has analysed the 2018-19 budgets of 13 major states — Andhra Pradesh, Bihar, Chhattisgarh, Gujarat, Haryana, Kerala, Maharashtra, Punjab, Rajasthan, Tamil Nadu, Telangana, Uttar Pradesh and West Bengal. Our analysis covers the key fiscal trends in their Budget Estimates (BE) for 2018-19. Moreover, we have compared the projections made in their Revised Estimates (RE) for 2017-18, with the provisional trends for the first eleven months of 2017-18, to gauge the reliability of their forecasts.

 

The aggregate data for the sample indicates a robust expansion of 21.3 per cent, 20.8 per cent and 13.2 per cent, respectively, for revenue receipts, revenue expenditure and capital outlay in the RE for 2017-18. However, the provisional data for the first eleven months of 2017-18 released by the Comptroller and Auditor General of India for these state governments indicates a relatively subdued performance, with a growth of 11.2 per cent and 10.2 per cent, respectively, for revenue receipts and revenue expenditure, and an unfavourable eight per cent contraction in capital outlay. The variance between the growth forecast by the RE for the full year and the data for 11 months reveals the challenge in assessing the outlook for the states’ fiscal health, based on the trends projected in their BE, and reiterates that the budgetary trends must be critically dissected to determine their accuracy.

 

The 2018-19 BE of the states in the sample has forecast a higher growth of their revenue receipts (14.4 per cent) relative to their revenue expenditure (10.6 per cent). They have thereby projected a sharp improvement in their revenue deficit to Rs 143.6 billion in 2018-19 BE, from Rs 733.4 billion in 2017-18 RE, freeing up space for a 17.1 per cent expansion in capital spending.

 

Notwithstanding the sharply higher growth in capital outlay, relative to revenue expenditure in the 2018-19 BE, the quality of expenditure (share of capital spending in total expenditure) is budgeted to improve only mildly to 15.1 per cent in 2018-19, from 14.4 per cent in 2017-18 RE. The imposition of the model code of conduct, ahead of the assembly elections, likely to be held in four of these 13 states over the next 15 months, may constrain capital spending in 2018-19. Accordingly, the budgeted improvement in the quality of expenditure in 2018-19 may not materialise.

 

These states have forecast a mild decline in their fiscal deficit to Rs 3.5 trillion in 2018-19 BE, from Rs 3.7 trillion in 2017-18 RE. Nevertheless, this improvement remains contingent on meeting the budgeted growth in revenues and limiting the expansion in revenue expenditure, in the absence of which the states may defer capital spending as a mechanism to rein in their fiscal deficits in 2018-19. In this context, recently released data revealing a rise in GST collections to above Rs 1 trillion in April 2018 is encouraging.

 

Despite the aforesaid decline in the fiscal deficit forecast by 13 major states, the indicative calendar of market borrowings by all 29 state governments and Puducherry released by the RBI, indicates a sharp rise in planned gross SDL issuance to Rs 1.16-1.28 trillion in the first quarter of 2018-19, from Rs 0.65 trillion in the first quarter of 2017-18. This spike is likely to have been led by the change in the states’ assessment of their cash flows, following the modification in the timing of devolution of central taxes, rather than portending impending fiscal deterioration, in ICRA’s view. Notably, high yields appear to have prompted the cancellation of around a quarter of the announced SDL sales by various states in April 2018.

 

With mixed cues so far in 2018-19, the key trends to watch out for to assess the states’ fiscal health include the level at which the GST collections settle after the pan-India rollout of the e-way bill, the extent to which funds are released towards the crop loan waivers announced last year, and whether additional expenditure announcements are made by the states in the run-up to the Parliamentary elections.  

 

Jayanta Roy is Group Head - Corporate Sector Rating, ICRA Limited, and Aditi Nayar is Principal Economist at the rating agency


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