India’s public sector borrowings remain sticky and at elevated levels; however, the underlying mix has been changing. The period FY13-17 was characterised by the Central government lowering its fiscal deficit, and states offsetting some of those efforts by running wider deficits in almost each of the years.
India’s public sector borrowings remain sticky and at elevated levels; however, the underlying mix has been changing. The period FY13-17 was characterised by the Central government lowering its fiscal deficit, and states offsetting some of those efforts by running wider deficits in almost each of the years. Between FY12 and FY17, the consolidated state deficit had risen from 1.9% to 2.8%. However, after lowering the deficit every year since FY13, the Central government paused in FY18. The Central government’s fiscal deficit came in at 3.5% of GDP, the same as in the previous year. The FY19 and FY20 estimates of 3.4% each also did not show much consolidation either. On the other hand, after rising almost every year since FY13, the state fiscal deficit fell notably in FY18. What is driving this fall? And are we at an inflection point for state finances?
At the start of a fiscal year, every state announces the ‘budget estimate’ for the fiscal deficit. Towards the end of the year, they announce a ‘revised estimate’. And, one year later, they release the ‘actual’ data. Actual data is superior as it is audited and, therefore, final. The coexistence of three versions of the data would not have created much problem had it not been for the fact that over the last few years, the ‘actual’ aggregate state fiscal deficit is turning out to be lower than the revised estimate. And the difference is rising. This creates a problem. Until the actual data are available a year later, how does one think about the state fiscal stance? Is it rising, or falling? What is not subject to revision, though, is every state’s net market borrowings. Over the last three years (FY16-18), net market borrowings are funding about 80% of the state fiscal deficit (excluding UDAY borrowings). Assuming that the proportion remains unchanged, a rough estimate of the ‘actual’ fiscal deficit can be worked out.
The actual fiscal deficit has been higher than the previous year’s fiscal deficit for almost every year between FY13 and FY17.
However, FY18 seems different. RBI had pegged the FY18 ‘revised estimate’ at 3.1% of GDP, higher than the 2.8% ‘actual’ deficit of FY17. But the study of recently released 18 state budget documents suggests that the FY18 ‘actual’ could be closer to 2.5% of GDP, lower than the 2.8% ‘actual’ fiscal deficit in FY17. This marks the first notable fall in the ‘actual’ state fiscal deficit in five years.
Net market borrowings fell by 0.2% of GDP between FY18 and FY19. Assuming that the proportion of state deficit funded by market borrowings remains at least 80% as in the previous year, the FY19 actual fiscal deficit to be released next year will turn out to be lower than the FY19 revised estimate of 2.9%.
FY20: The 18 state budget documents suggest that India’s states are pegging a fiscal deficit of 2.5% of GDP for FY20. This implies that the FY20 state deficit, too, may be no worse or no better than in FY19. All said, while the states are running higher deficits than a decade ago, they have inched lower compared to their FY17 highs. And perhaps there are some good reasons supporting this. A confluence of factors was pressuring RBI over the FY13-17 period: (1) The Seventh Pay Commission (SPC) called for a higher wage and pension bill. (2) UDAY borrowings raised the interest bill. (3) Lower oil prices hurt tax revenues. (4) And the slowdown in the real estate sector depressed stamp duty revenue. Some of these drivers have faded. Most SPC wage increases are done. UDAY borrowings are done. And oil prices are higher than a few years ago.
Alas, things don’t look as good with all parts of the fiscal picture put together: –
Elevated borrowings: Despite states running lower fiscal deficits, borrowings in FY20 are likely to grow faster than nominal GDP growth and are likely to remain elevated at 8% of GDP. There are three reasons for this.
PSE borrowings: These have ‘galloped’ in recent years. Almost half of the `4.5 trn PSE borrowings in FY19 were by the Food Corporation of India.
Central government borrowings: Borrowings are likely to rise 24% y-o-y in FY20, led by a sticky fiscal deficit and a rapid rise in the repayment bill.
State redemptions: With state borrowings having risen over the last few years, the redemption bill is on the rise. It has risen from 0.2% of GDP in FY16 to 0.7% of GDP in FY19. Looking ahead, it cannot be said with certainty that they are at an inflection point. Two of the reasons are as follows:
Oil: The value-added sales tax on petroleum products accounts for 15% of the states’ self-collected tax revenues. This leaves them vulnerable to oil price volatility.
Rural schemes: Over the last year, several states have announced farm loan waivers and direct cash transfers. If more and more states join the fray, without ‘weeding’ out old schemes, this could lead to a ratcheting up of current expenditure.
For FY20, all three arms of the government—the Centre, the states and the PSE—are budgeting a lower capex spend. There is a double whammy for capex. The government is not spending much on investment. And the private sector is being crowded out as the government is running an elevated fiscal deficit. Over time this could weigh on India’s potential growth. Elevated borrowings and insufficient capital expenditure are likely to keep us on guard, despite some improvements in state finances.
The writer is Chief economist, India HSBC Securities and Capital Markets
Edited excerpts from HSBC’s India’s enigmatic state finances (April 15)
Co-authored by Aayushi Chaudhary and Deep Nagpal