Ballooning state debt
Populism and profligacy undercut India’s fiscal stability
The newly elected government of Uttar Pradesh presented its first Budget last week. There was considerable interest in the run-up to the Budget presentation, given that the Bharatiya Janata Party had promised on the campaign trail to waive off large amounts of agricultural debt and that Union Finance Minister Arun Jaitley had specifically said that the central government would not pay for the loan waiver. The loan waiver might cost as much as ~36,000 crore. Since Uttar Pradesh was already deeply indebted — with a state debt-to-state gross domestic product ratio of around 30 per cent — the question was how would this fresh call on the exchequer be managed? The answer is now available, and it does not inspire confidence. It turns out that the extra spending will be managed through two changes from the interim Budget presented earlier. First, the government has reduced its power allocation by ~16,800 crore. And second, total revenue is projected to increase by 18.6 per cent over the previous year, as opposed to an 11.4 per cent increase in the interim Budget. It turns out that much of this increase will, in fact, be through grants from the Centre, regardless of Mr Jaitley’s assurances. According to the Uttar Pradesh Budget, grants from the Centre will grow by an unusually large 39 per cent to ~68,000 crore. If for some reason that largesse from the central government does not materialise, then the state’s fiscal deficit will only rise.
Uttar Pradesh’s problems are not unique. Other states that have promised farm loan waivers, Punjab and Maharashtra among them, will have similar problems in raising revenue while meeting their fiscal targets. Meanwhile, pressure is growing on other states across the country to meet demands from farmers under stress after two consecutive droughts followed by demonetisation. Already state-level finances were showing signs of serious strain, starting in financial year 2015-16. For the first time in a decade, the ratio of gross state fiscal deficits to the gross domestic product (GDP) crossed the 3 per cent threshold to hit 3.6 per cent. The problem continued into 2016-17, according to the Reserve Bank of India’s report on state finances. The RBI report also warned that, aside from loan waivers, state finances would suffer from the implementation of Pay Commission recommendations and from the revenue uncertainty associated with the implementation of the goods and services tax.
The markets are already responding to this unsustainable spending path. Spreads on state debt over sovereign paper of equivalent maturity have widened to between 74 and 83 basis points, up from around 50 basis points last October. The problem is not just that India’s overall fiscal position, judged by the ratio of general government debt to GDP, will suffer through states’ profligacy and populism. It is also that the money being spent will be diverted from important alternative uses. Capital expenditure might suffer, particularly expenditure targeted towards the agricultural sector, which has faced chronic underinvestment for years. Fears over ballooning state deficits have been expressed for some months now, but the Uttar Pradesh Budget suggests that these have been, if anything, understated.