Rating of state development loans (SDLs) by credit rating agencies could be explored to introduce fiscal discipline among the state governments, economic affairs secretary Ajay Seth said on Friday.
The comment assumes importance as some states don’t rein in revenue expenditures to the required extent, and invest sub-optimally in productive assets. This exacerbates their debt levels.
The 15th Finance Commission had pointed out that SDLs have not been able to attract investors, specifically foreign portfolio investors due to lack of financial information on the states.
It also observed that states are neither rewarded nor penalised for their debt performance. This concern was also echoed by states with better fiscal parameters.
“It’s a bit of a loud thinking, just like external rating agencies do rate the government of India…So, even starting that process of doing the rating of state government loans will be an important signal to happen. Today, the debt papers of the state governments are treated more or less the same, irrespective of whether the state debt to GDP ratio is 50% or it is 20%,” Seth said at Ashoka University’s first Annual Growth Conference 2025.
“My request would be that our think-tanks and organisations start working in those areas,” he added.
Currently, the centre imposes fiscal discipline on states through the mandatory borrowing consent under Article 293(3) of the Constitution. This is being challenged in the Supreme Court by the Kerala government.
A NCAER report recently said that the RBI should review its policies of intervening in the markets to cap spreads on the bonds of heavily indebted states. Limiting such intervention would strengthen market discipline.
Despite various fiscal incentives and support, more than half of the states, including high-income states are revenue-deficient due to their focus on consumption spending rather than on investment to boost economic activity, Seth said.
The RBI State Finances Report 2024 noted that SDL rate differences across states are small. Especially striking is the comparison between Gujarat and Punjab. Punjab, with a debt-to-GSDP ratio of over 45%, has the same average rate on its securities as Gujarat, which has a debt-to-GSDP ratio of about 20%. The weighted average cut-off of the SDL in FY25 was 7.2%.
The discussions in the Centre and statutory bodies on the rating of SDLs and how to go about it have been internally debated for the last five years. Finally, the government seems to be veering towards a mechanism, possibly through some incentive mechanism to induce states to go for rating of their bonds. The 16th Finance Commission’s report may have some reference on this as well.
“Including some of the high income states, many states are moving towards financing (more) current expenditure rather than investing. That is something, an area we have to find ways not to travel into that path,” Seth said.
In 2017, the NK Singh Committee recommended a ceiling for general government debt of 60% for the Centre and 20% for states. The general government debt level in India is currently over 80% with the Centre’s share about 57%. However, speaking at the event on Friday, Singh said these 60%:40% limits prescribed need to be re-examined in the current environment post-COVID due to the rise in debt levels.
Tightening of the norms saw a dramatic reduction in the off-budget borrowing by states in the last two years.