The size of the power liability of R1,93,000 crore for the states brings above the line the contingent liabilities that in any case already existed for them. These contingent liabilities have been frightfully difficult to estimate for RBI or for the successive Finance Commissions, so bringing them above the line creates transparency. This makes lenders more comfortable. But a comparison by size shows that the power bill is similar to the last Pay Commission award.
This means that if the Seventh Pay Commission arrives before the General Elections of 2014, the states will be clearing two similar awards from their budgets. To get a sense of where this can land the states, one needs to do a check on their current finances. This will give an indication of the nature of adjustments that state governments have got to undertake to bring their budget into order once the above awards enter their books.
On a consolidated basis, the state government budgets show a revenue surplus of 0.1% of the GDP for 2011-12. This reflects an improvement since the Sixth Pay Commission sunk them in 2009-10. But the surplus is lower than the target for the year as states revenue expenditure has exceeded their revenue receipts for the first time since then. Obviously, this has impacted their fiscal deficit, which is higher than the progressive target set by the Thirteenth Finance Commission.
While this is something that the states can be expected to cure if the economy moves faster this year, since their tax earnings will rise, they have fought to keep their budgets in control by cutting aggregate capital expenditure. An RBI analysis shows that even without the power sector hit, in the current fiscal, states development and social sector expenditures were expected to decline as a percentage of GDP. The cutback in capital outlay is more severe if it is compared against states estimated increased outlay. An Icra study of the six large states of Andhra, Gujarat, Maharashtra, Punjab, Karnataka and Tamil Nadu had found each of them had projected at least a 15% growth in capital outlay for 2011-12 for irrigation, transport, urban and rural development sectors.
So we have two pressure points already weighing on state budgets. The liabilities of the power sector will be the third. If the Centre adds to this the impact of the Seventh Pay Commission for state government employees, it can wipe out all the gains made so far by making states sign on to the Fiscal Responsibility and Budget Management Act.
An RBI study of state government finances also shows that outstanding guarantees of state governments at the end of March 2011 amounted to R1,30,000 crore. This is about 10% of their total budget numbers. Contingent liabilities, since they are not quantified, do not form part of this accounting.
But even as the states have chipped away at their guarantees, their contingent liabilities have increased. Contingent liabilities of the state governments could be much higher than is evident from their budget documents, the RBI report says.
The highest degree of expansion in the contingent liabilities made by the states is where they have underwritten infrastructure investments made through public-private partnerships. The Thirteenth Finance Commission had asked the states to quantify the expenditure obligations relating to PPP projects in their medium term fiscal policy statements, with an increasing number of them adopting (this) mode of project implementation. Only the governments of Karnataka and Tamil Nadu have obliged. And the pace of PPP projects is expanding rapidly, meanwhile.
The nature of the pressure is also skewed against the poorer states. Uttar Pradesh, Punjab, Rajasthan and Orissa have to do some of the largest corrections for their unmet power bills.
And all this happens when the states have moved to finance their expenditure beyond their own revenues through borrowings from the markets. They have one advantage, though. All their papers are treated as eligible for SLR treatment. So banks are willing to lend them at comparable rates to what the Centre gets. And most of the strength of the state borrowings will be riding on the guarantees offered by the central government. The power sector reforms then mean that the states are asking the banks to depend on them (the states) to keep their papers solvent. The states, in turn, share with the Centre a sovereign guarantee on their papers as a backstop to their borrowing. The Centre, in turn, gives the banks (largely public sector ones) a guarantee that their impaired loans from the state electricity boards will not harm their books. It might be good for the Fourteenth Finance Commission to check back if this circular pattern of backstopping is enough to keep confidence levels high.