Is the debt of certain States reaching precarious levels?
The pandemic has disrupted the finances of all economies, with the budget deficit rising sharply in 2020-21, leading to a sharp increase in the debt burden. State finances are no different, with spending up and revenue down in the first year of the pandemic, forcing them to resort to additional borrowing to fill the budget gap.
The finances of some states were already in trouble due to a large part of the expenses incurred and the subsidies not being matched by their revenues. So how are states positioning themselves in their market borrowing during the pandemic? How many of them have crossed the debt ceiling imposed by the finance commission? Which States are likely to have difficulty servicing their debt?
To find answers to these questions, we analyzed borrowing and debt-related ratios for the 15 states with the highest gross state domestic product (GDP). The states in the sample represent over 86% of the GSDP of all states and union territories.
Market Borrowing Peak
Most states increased market borrowing during the pandemic as their budget deficits grew.
Tamil Nadu tops the list of states with the highest gross borrowings in the market in fiscal 21 and 22. According to Reserve Bank of India (RBI) data, the gross borrowing of the state has stood at ₹87,977 crore and ₹87,000 crore in FY21 and FY22 respectively. Its borrowing was up 39.4% from pre-pandemic borrowing in fiscal 2020. While market borrowing in Maharashtra, the country’s largest economy, jumped nearly 42% to ₹68,750 crore (from ₹48,498 crore) during this period. Kerala recorded the sharpest jump among the states in the sample. Its borrowing increased by nearly 50% to ₹27,000 crore in FY22 from ₹18,073 crore in FY20.
But not all states were borrowing. Odisha stayed away from borrowing from the market through State Development Loans (SDLs) in FY22. in good health. Its market borrowings decreased to ₹3,000 crore in FY21 from ₹7,500 crore in FY20. Borrowing from a few National Democratic Alliance (NDA) led states like Uttar Pradesh, Gujarat and Madhya Pradesh also declined between FY20 and FY22.
“Several states have seen their debt levels increase over the past few years, which will inflate their interest payments and reduce fiscal space for other short-term priorities. Guarantees and off-budget debt also appear to have increased in some states, whose debt servicing could limit fiscal space in the coming years,” said Aditi Nayar, Chief Economist, ICRA.
However, increased market borrowing does not always indicate that the government is in dire fiscal straits. We analyzed state borrowing using other metrics to see which of them might have trouble servicing debt or making interest payments.
Debt to GSDP
Looking at a state’s debt against its GSDP is a better way to gauge which states are biting more than they can chew. Punjab seems the most precarious based on this parameter; growing government borrowing has taken its debt-GSDP to an alarming 53.30% according to revised FY22 estimates. Punjab’s FY23 debt and GDP estimates are not available. According to reports, Punjab Chief Minister Bhagwant Mann has ordered an investigation to find out the reasons for spiraling debt in the state which has now exceeded ₹3-lakh crore.
The Fiscal Responsibility and Management (FRBM) Act of 2005 sets the ceiling on the debt-to-GDP ratio at 25%. Eight of the 15 states studied here exceed the prescribed limit in FY22. Odisha was clearly an outlier with a debt to GSDP ratio of 15.79%. States like Tamil Nadu and Karnataka were slightly above the prescribed limit.
Gujarat and Maharashtra have managed to keep their debt below 20% of their GSDP, mainly due to their strong industrialized economies which result in large revenue streams.
Fiscal deficit to GDPP
The heavy borrowing of some states is due to the sharp expansion of their budget deficits, well beyond the prescribed level. The FRBM law prescribes the budget deficit limit at 3 percent of GDP. Given the pandemic’s extraordinary budgetary pressure on state finances, the Fifteenth Finance Committee set the normal net borrowing limit at 4% of GDP for 2021-22, 3.5% for 2022-23 and 3% for 2023-24 to 2025. -26. An additional conditional loan of 0.5% of the GSDP has been proposed for the years 2021-22 to 2024-25, depending on reforms in the electricity distribution sector.
Bihar recorded the highest budget deficit to PISG ratio at 11.30% according to revised FY22 estimates, followed by Rajasthan (5.2%), Punjab (4.60%) and India. Uttar Pradesh (4.27%).
“Rising state debt can be directly attributed to the growing borrowing that comes from the budget deficit spiraling out of control. As states use the added ease of a 0.5-1% budget deficit due to the pandemic, they have increased their debt,” said Madan Sabnavis, Chief Economist, Bank of Baroda.
“Also, they (the states) have taken on longer-term debt as opposed to the 10-year standard followed, say, five years ago. This in turn keeps their level of debt higher for an extended period as they will be repaid later,” he added.
High borrowing or the fiscal deficit to GDP ratio are not cause for concern as long as governments have enough surplus revenue to finance them. This can be assessed by looking at interest coverage as measured by the state’s tax revenue divided by its interest payments.
For example, Bihar had the highest budget deficit as a percentage of GSDP, however, the state has sufficient revenue to cover its interest burden, with an interest coverage of 11.3. Odisha tops the list with the highest interest coverage ratio as it has diligently reduced its borrowings along with the resulting interest burden.
Punjab, Haryana, West Bengal, Tamil Nadu and Kerala look weak by this metric with less than 6x interest coverage.
The multiplication of borrowings has led to an increase in the interest burden of the states in the sample. Bihar’s actual interest expenditure increased by more than 72% from FY2019 (normal year) to FY22 post-pandemic. Karnataka and Telangana also saw interest expenditure increase by 50% during this period.
Sabnavis said state revenue momentum has already been affected since the Goods and Services Tax (GST) took effect and states’ ability to raise taxes has diminished. “To top it off, as interest payments keep rising, their coverage ratios are affected.”
Interest payments, salaries and pensions are incurred expenses of state governments. According to a report by SBI Ecowrap, which looked at the fiscal situation of 18 states, Kerala and Tamil Nadu’s committed expenditures accounted for 71% and 67% of their budgeted revenue in FY23, respectively.
“A greater proportion of the budget allocated to committed expenditures limits the state’s flexibility to decide on other spending priorities such as development projects and capital expenditures,” the report notes.
Sabnavis of the Bank of Baroda said that with the share of outlays high, states have less leeway to spend on social and economic development.
“The conundrum is that with less flexibility to raise taxes, states have to find other ways to generate revenue like asset monetization or they will be plunged into this syndrome,” he added.
June 05, 2022