The proposed fiscal tightening by states in 2017-18 was anyway optimistic given that it came after two successive years of major fiscal slippages on their part, the looming Pay Commission costs, continuing UDAY interest liabilities and Finance Commission-awarded enhanced borrowing window that many of them might be tempted to use. Now, with states climbing aboard the farm loan waiver bandwagon one after the other, the ambitious plan for fiscal correction is bound to go haywire. In a year the Centre has begun budget spending briskly and unconventionally early and there is continued pressure on it to spur growth in an environment of tepid private investments, the harm to fiscal consolidation from states’ extravagance will be substantive. If the states finance the largesse promptly out of their budgets, the deficits will surge dramatically in 2017-18 and if they chose to issue off-budget bonds, the fiscal numbers will be affected less in the current year, but would still beg the credibility question. With finance minister Arun Jaitley saying — he reiterated on Monday — that farm loan waivers will be at the sole cost of the respective state governments, an UDAY bond-type solution that will securitise banks’ farm loans into long-dated non-SLR state government paper looks unlikely.
The result: States’ interest costs could skyrocket and their debt-to-gross state domestic product (GSDP) ratios could turn considerably worse, frustrating the NK Singh committee roadmap to keep these ratios at 21% over an eight-year time-frame with a steady-but-modest reduction in the primary and fiscal deficits. Already, the interest differential between state government bonds and those issued by the Centre has widened to nearly 100 basis points in May 2017 from the usual 40-50 basis points. “The gross market borrowings of the state governments will rise by 22% from Rs 3.7 lakh crore in FY17 to Rs 4.5 lakh crore in FY18, which would exert an upward pressure on state development loans (SDL) yields,” Icra said recently.
That was before the loan waiver series was inaugurated by Uttar Pradesh’s Yogi Adityanath government in April. Against 3% of GSDP originally budgeted, the gross fiscal deficit of states (GFD) of states ended up at 3.4% in 2016-17 (25 states have put in the revised figures but some including Uttar Pradesh haven’t ). After being firmly on the consolidation path till 2014-15 (thanks to enhanced VAT revenues), the states breached the FRMB mandate of 3% fiscal deficit in 2015-16 (mainly because their own tax revenues slipped) to report a much worse number of 3.6%. Despite this, the current year’s deficit of states is pegged at a benign 2.6% along with the Centre’s 3.2%. Clearly, the plan is unimplementable, at least for the states.
Bank of America Merrill Lynch predicted that various state governments would waive off Rs 2.57 lakh crore (2% of GDP) worth farmers’ loans in the run-up to the 2019 general elections. That doesn’t look an exaggeration given that UP and Maharashtra have already announced waivers of over Rs 71,000 crore and many others including Madhya Pradesh, Punjab and Karnataka are expected to come out with similar packages for farmers in coming days. Maharashtra’s farm loan waiver — which latest reports say will be capped at Rs 35,000 crore — will increase its fiscal deficit to 2.91% of GSDP from 1.53% budgeted in 2017-18. Of course, Maharashtra has conventionally been among the fiscally more responsible states and even after the loan waiver its fiscal deficit would not much higher than the 2.82% limit recommended for states by the FRBM committee recently.
But the state would have found it difficult to stick to the budgeted deficit in the current year even without the grand gesture to farmers. Despite almost meeting revenue targets, the state had a deficit of 2.22% in 2016-17, against the targeted 1.54%, as expenditure surged. With salaries and pensions accounting for about 40% of total expenditure, the state’s capital spending is already constrained (the proposed loan waiver is equal to the capex planned for the current year). Also, being a “manufacturing state”, it is facing some uncertainty over sustaining tax revenue buoyancy in the upcoming goods and services tax (GST) regime; at least in the initial months it could feel transition pains.
The loan waiver for farmers will be more debilitating for states like UP, Punjab, etc, as they are already in more precarious fiscal situations. Even though the revised estimate for UP in 2016-17 and the budget estimate for the current year are not yet available due to the delay in budget presentation, the country’s most populous state had budgeted for worrisome 4% (excluding UDAY) fiscal deficit in 2016-17. While it is possible even this level has been breached, things could turn more problematic in the current year. The Rs 36,360-crore largesse to be given to the state’s farmers is a substantial 2.6% of the state’s GSDP.
The UP government has already announced to float Kisan Rahat Bonds to finance the debt waiver, but it remains to be seen whether the entire bond amount and interest cost will be factored in the budget. The state is an outlier in debt-to-GSDP ratio (over 30%) and this might aggravate. “The states can announce farm loan waivers, but it should be subject to their FRBM ceilings. Such borrowings to finance debt waivers should reflect in their fiscal deficit numbers rather than keep them off-budget… There should be transparency,” said Sudipto Mundle, member of 14th Finance Commission.