Given how states’ finances are turning increasingly precarious, as seen from the 2017-18 data, it is just as well RBI has tightened norms for valuing their debt. In June, the central bank had said that these securities would be valued on the basis of ‘observed prices’ or market prices; earlier, these were being benchmarked at a mark-up of 25bps over the relevant central government securities.
Consequently, states were borrowing at more or less the same rates regardless of the health of their balance sheets. However, given the somewhat reckless manner in which farm loans are being written off—the Karnataka government has now waived off loans valued at a staggering amount of Rs 44,000 crore—it is time state debt is marked to market. RBI has observed that, despite not being able to generate adequate revenues, states continue to spend, with the result that their gross fiscal deficit in 2017-18 hit 3.1% of GDP against a target of 2.5%.
Expenses are soaring, partly due to higher salaries for government employees and interest costs, but also because many states are resorting to large-scale loan waivers. The total debt waiver granted during 2017-18 amounted to 0.32% of GDP, against the budgeted 0.27%; in the current year, the waivers are budgeted at 0.2% GDP. However, it is very likely this target will be breached. The impact on the exchequer could be highly deleterious for some states such as Uttar Pradesh where it was nearly 61% of gross fiscal deficit.
What this means is that states will have less to invest in development schemes—already, capital expenditure in 2017-18 was flat at Rs 5.10 lakh crore; given how states cut back on spends towards the end of the fiscal, the capex for 2018-19 could turn out to be even smaller. In contrast, the revenue expenditure shot up to Rs 25.2 lakh crore from Rs 20.87 lakh crore in 2016-17. The rise in revenue expenditure resulted largely from expenses on natural calamities—floods, for instance—and spends on social security and welfare, but also from interest payments. As RBI has pointed out, the deterioration in states’ finances, in aggregate, has taken place despite the UDAY scheme having been discontinued.
Unless revenues are used more efficiently, states are unlikely to be able to fund infrastructure development. Loan waivers, while providing immediate relief to farmers, will not help them in the long term since banks would be wary of lending to them—Telangana’s Rythu Bandhu model is probably a better way to help the farming community. But, states must remember that higher fiscal deficits, resulting from debt waivers, are unlikely to result in a growth in the GDP as they might if the expenditure is on infrastructure projects.