Fiscal deficit targets: Why Centre’s leeway to states is of little use

By: and |
Updated: Apr 26, 2016 1:26 PM

Most states, it appears, would not be able to exercise benefits of the extra fiscal borrowing space the Centre is providing, as it is likely going to be a tightrope for them, considering the conditions they need to fulfill.

While approving the additional borrowing space for the states, the central government had emphatically argued this would lead to higher spending for capital projects and infrastructure in the states. While approving the additional borrowing space for the states, the central government had emphatically argued this would lead to higher spending for capital projects and infrastructure in the states.

Even as the Centre provided additional leeway to states earlier this month to stretch beyond their fiscal deficit targets, only a handful of states would actually end up qualifying for this extra space. Reason: A majority of the states simply are in no position to meet the stiff conditions recommended by the Fourteenth Finance Commission (FFC).

The implication of this for the states that do not make the cut is that in the short term, since the revenue raising options for them are likely to be constrained on account of factors such as the pressure of implementing Pay Commission recommendations, states will either have to resort to pruning capital expenditure or look for additional options to raise revenue. While approving the additional borrowing space for the states, the central government had emphatically argued this would lead to higher spending for capital projects and infrastructure in the states.

debtAccording to the CARE Rating analysis, though, only five out of the nineteen states assessed can use the window to raise extra resources. “Only five states namely — Gujarat, Karnataka, Madhya Pradesh, Odisha and Telangana — have indicated revenue surplus for both years, while other states disqualify as per prescribed norms. Therefore, only these five states are entitled for the additional borrowing limits over and above the fiscal deficit target of 3 per cent of GSDP (Gross State Domestic Product) provided they comply with other two conditions for fiscal flexibility,” the rating agency said.

The Union Cabinet on April 6 approved recommendations of the FFC on states’ fiscal deficit targets, enabling extra space for their borrowing for four years starting 2016-17 subject to fulfillment of FFC conditions as specified in the FFC recommendations. FFC had adopted the fiscal deficit threshold limit of 3 per cent of GSDP for the states. The Cabinet has provided additional headroom to a maximum of 0.5 per cent over and above the normal limit of 3 per cent in any given year to the states.


The conditions are that states should have no revenue deficit this year and in the preceding year. They will be eligible for flexibility of 0.25 per cent over and above the fiscal deficit limit of 3 per cent of GSDP if their debt-GSDP ratio is less than or equal to 25 per cent in the preceding year. States will be further eligible for an extra borrowing limit of 0.25 per cent of GSDP this year if the interest payments are less than or equal to 10 per cent of the revenue receipts in the preceding year.

Economists believe with the restrictions in place, the options to raise revenue by states in the short term are quite constrained. “The additional borrowing space allowed by Centre does provide an incentive to states to incur expenditure for necessary purposes. But in the short term, since the options of states to raise revenues are constrained and also, with pressure of implementation of Pay Commission, states will have to either cut capital expenditure or look for additional options to raise revenue,” Nomura India’s economist Sonal Varma said.

“For long term, the Centre needs to implement GST (Goods and Services Tax), which will increase revenue buoyancy and help states. Otherwise without revenue buoyancy, states will find it difficult to meet their fiscal targets without undertaking expenditure cuts,” she added.


revenueDuring the meeting with state finance secretaries, finance secretary Ratan Watal had called for higher capital expenditure at state-level in wake of the recent nod to higher borrowing space, higher tax devolution and more grants in aid. “The states will get additional space to raise borrowings, which may result in such needed government expenditure for capital projects and infrastructure,” Watal had said. But, since only a few states are meeting the conditions, the additional borrowing space would not be available to most of them.

Among the five states that can utilise this limit, Karnataka, Madhya Pradesh, Odisha and Telangana have the interest payment to revenue receipts ratio less than 10 per cent as well as the debt-GSDP ratio of these four states is below 25 per cent. Thus, they are entitled for 0.5 per cent headroom over and above the fiscal deficit-GSDP target of 3 per cent, implying the fiscal deficit–GSDP limit of 3.5 per cent in any given year, as per the CARE Ratings report. Gujarat, that enjoyed revenue surplus for last two years, has the debt-GSDP ratio of 24.20 per cent, below the prescribed limit of 25 per cent. However, the interest payment to revenue receipt ratio is above 10 per cent. As a result, Gujarat can enjoy the additional headroom of only 0.25 per cent, making the fiscal deficit-GSDP limit of 3.25 per cent for the state for 2016-17, the report said.

Although the other states did not comply with the revenue condition, some are meeting with the other two statuses of interest payment to revenue receipt and debt to GSDP ratio. Goa, Himachal Pradesh, Kerala, Punjab, Rajasthan, and West Bengal did not comply with any of the prescribed criteria under the fiscal deficit flexibility rules.

States’ debt to rise

With their fiscal deficit limits stretched to the limit, market borrowings by the states are set to rise sharply in the current financial year due to combination of reasons, including low revenue buoyancy, the need to provide for interest payments on UDAY (Ujwal Discom Assurance Yojana) bonds and higher wages for states’ employees in line with implementation of the Seventh Pay Commission’s proposals, among others.

On the back of already heavy borrowings of around Rs 3 lakh crore raised in 2015-16, states are now estimated to borrow nearly Rs 3.5 lakh crore in 2016-17. States raised Rs 2.4 lakh crore in 2014-15 through market borrowings. Borrowings by states are now more than half of the debt the Centre would raise this year. In the Union Budget 2016-17, the Central government has estimated its gross market borrowing at Rs 6 lakh crore and net borrowing at Rs 4.2 lakh crore.

States’ market debt will rise as they take over their power distribution companies’ debt via UDAY bonds in 2016-17. In March last financial year, states issued around Rs 1 lakh crore of UDAY bonds and this issuance will continue in the current year too. Interest payments on UDAY bonds will get added to states’ expenses, prompting them to raise more resources via market borrowing.

While states have made realistic revenue assumptions for the current fiscal, they have underestimated expenditure, HSBC said in a March 2016 research report. “State governments are grappling with two new spending pressures — the interest bill on UDAY bonds and pay commission wage hikes. Accounting sufficiently for both suggests that state deficit could rise to 2.9 per cent of GDP in FY17 from a revised 2.7 per cent in FY16 (aggregate for 17 States),” HSBC said.

Under the UDAY scheme, the government had asked states to voluntarily take over 50 per cent of the loans of state electricity boards by March 31, 2016 and 75 per cent by the end of March 2017. These taken-over loans will not be counted for the states’ FRBM for 2015-16 and 2016-17. The states, in turn, have the facility of a concessional interest rate of about 9 per cent for servicing the loans, as against rates of over 13 per cent that is charged at present on state electricity boards’ outstanding debt.

The elevated borrowings would mean states have to pay higher price to attract buyers. “Yields on government bonds are unlikely to soften in FY17. Also, there will be an incentive for UDAY bonds, whose interest rates are higher than State Development Loans, which is in turn higher than central government securities,” CARE Ratings chief economist Madan Sabnavis said.

Also, states may face fiscal pressure on due to overestimation of their share of central taxes in FY17. Nomura in its report on fiscal finances of states said, “…we find that several states — Bihar, Chhattisgarh, Gujarat, Tamil Nadu, Jharkhand, Madhya Pradesh, Kerala and West Bengal — have over-budgeted their share of tax transfers. Together the 15 states have budgeted Rs 1.1 trillion rupees more than the Centre has indicated, suggesting fiscal slippage of 0.7 percentage point of their combined GSDP.”

Election-related spending is also expected to burden states’ finances, Nomura’s report said. “With elections in two large states, Punjab and Uttar Pradesh, scheduled for H1 2017, we expect pre-election spending to continue for at least another year. This is important because, of the Rs 537 billion incremental state borrowing in FY16 (over FY15), 26 per cent was accounted by UP and Punjab alone,” it said.

Features of some state Budgets

Andhra Pradesh
It’s the first e-Budget, with all Budget documents being made available in easily readable format on a tablet. It’s a truly decentralised Budget with every drawing and disbursing officer (DDO) in the state having prepared the proposals for the unit under his/her control. In a major boost to the construction sector, the state has reworked its sand policy. It has decided to supply sand free of cost from all sand reaches in the state through a transparent mechanism.

Swaraj Fund Scheme, started in FY16, was successfully piloted in 11 Assembly Constituencies in FY16. Now, this Scheme is being extended to all the constituencies in FY17 wherein each Mohalla will be given funds to carry out works locally. Rs 350 crore have been allotted for Citizen Local Area Development scheme in 2016-17. The state will send teachers and principals for their professional development to some of the best universities in the world like Harvard, Cambridge and Oxford.

The state has levied Entry Tax to cover the goods coming in through e-commerce to provide level-playing field for dealers. A Bill to amend The Gujarat Tax on Entry of Specified Goods into Local Areas Act, 2001 will be introduced in the Legislative Assembly. The tax revenue is estimated to increase by Rs 30 crore annually.

Madhya Pradesh
The state plans collect details of goods purchased online through courier companies. It has proposed a 6 per cent tax on goods purchased online when they enter the state, saying e-commerce is resulting in revenue loss. The Budget also proposes a hefty increase in VAT on plastic products. Under the inter-caste marriage promotion scheme that aims to eliminate untouchability, couples used to get Rs 50,000, which will now go up to Rs 2 lakh. The state has a substantial population of Scheduled Castes.

Goods produced in jails would be exempted from VAT.

To ensure accountability in utilisation of funds and avoid parking of funds in bank accounts outside the State Treasury, the state has decided to open Personal Ledger Accounts instead of bank accounts. This ensures that funds remain under the state kitty and are drawn from the treasury only when there is an actual requirement. The state proposed to set up a Debt and Cash Management Cell in the Finance Department for effective monitoring and management of debt and cash flow.

With ENS input

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