Farm loan waivers a fiscal threat
The combined fiscal deficit (CFD) of states averaged 2.16 per cent during FY11-FY15, but came under pressure thereafter due to the Ujwal Discom Assurance Yojana (UDAY) and implementation of the Seventh Central Pay Commission recommendations. As a result, the CFD of the states in FY16 and FY17 (RE or revised estimates) came in at 3.07 per cent and 3.66 per cent, respectively. The states issued UDAY bonds of ~0.99 lakh crore in FY16 (0.72 per cent of gross domestic product or GDP) and ~1.10 lakh crore in FY17 (0.72 per cent of GDP). Excluding the UDAY bonds, the CFD of states works out to be 2.35 per cent and 2.94 per cent, respectively, for FY16 and FY17 (RE).
A reading of the budgets of 29 states shows that the CFD of states for FY18 has been pegged at 2.7 per cent (~4.48 lakh crore) of GDP. However, with several states announcing farm loan waivers, there is a fear that the CFD of states could be much higher. Our estimate shows that the CFD of states in FY18 would come in at 3 per cent of GDP (~4.99 lakh crore). This is higher than the budgeted figure but considerably lower than FY17 (RE) and includes the impact of the farm debt waivers announced outside state budgets and implementation of the goods and services tax (GST) from July 1, 2017.
The farm debt waivers announced by five states are likely to widen the CFD of states by ~1.08 lakh crore (0.65 per cent of GDP). This is marginally lower than the impact of UDAY scheme on the CFD of the states in FY16 and FY17. While the farm debt waivers announced by Uttar Pradesh and Punjab are part of their respective FY18 budgets, the farm debt waivers announced by Maharashtra, Rajasthan and Karnataka are outside their FY18 state budgets. Thus, these states will have to either generate additional resources or cut expenditure. It has been observed that if such announcements are funded through expenditure compression, the axe falls first on capital expenditure (capex), followed by social expenditure. Both cuts are detrimental to the mediumand long-term growth prospects.
If they are funded by additional borrowing then the burden falls on the future. After the 2008 global financial crisis, a number of states pursued expansionary fiscal policy as the fiscal deficit target was relaxed by 0.5 per cent of their gross state domestic product (GSDP) to pump prime their economies. As a result, aggregate market borrowings of the state governments increased by an additional ~0.21 lakh crore in FY10. Although this was also a period when state governments were moving away from National Small Savings Fund to finance their fiscal deficit, chickens are now coming home to roost. According to the maturity profile, the aggregate state development loan (SDL) redemption in FY19 will be 1.6 times of FY18 and 3.1 times of FY17. If the state revenue fails to support the full redemption then it will have to be refinanced. This simply means kicking the can down the road.
Perhaps the way out for the Maharashtra, Rajasthan and Karnataka is to follow Andhra Pradesh and Telangana which announced a farm debt waiver of ~0.43 lakh crore and ~0.17 lakh crore, respectively, in 2014. However, they adopted a staggered payment mechanism. They rolled over the announced farm debt waivers over four years with the last instalment due in FY18 to minimise the fiscal risk associated with such decisions.
As higher fiscal deficit of FY16 and FY17 would exert pressure on interest payment, interest payout for FY18 has been budgeted to increase to 1.76 per cent of GDP from 1.69 per cent in FY17 (RE). Besides the higher interest payout, the other component that will increase the committed expenditure of state governments is the salary revision after the Pay Commission. The share of select committed expenditure (salary, pension and interest) in revenue expenditure, therefore, has been budgeted to increase to 48.34 per cent in FY18 from 46.93 per cent in FY17 (RE).
The encouraging feature of FY18 state budgets, however, is near stability in the combined revenue deficit and some improvements in the combined primary deficit of the states compared to FY17 (RE). Another encouraging feature of FY18 state budgets is the continuation of capex by state governments. Boosted by UDAY issuances, the combined capex of states grew 40 per cent (yearon-year or y-o-y) and 26.2 per cent (y-o-y) in FY16 and FY17, respectively. However, excluding UDAY issuances, the combined capex grew 7.2 per cent and 30.9 per cent in FY16 and FY17, respectively. It has been budgeted to grow 19.3 per cent and would be 3 per cent of GDP in FY18. In comparison, the capex by the Union government has been budgeted to grow at 10.7 per cent, and would be 1.8 per cent of GDP in FY18. The aggregate capex by the states have been consistently higher than the capex of Centre since FY06.
In conclusion, it can be said that the stress emanating from UDAY and salary/pension revisions so far had been absorbed by states adequately and with relatively little damage to state finances and the debt sustainability. However, the same cannot be said about farm loan waiver if it continues and spreads to other states. The probability of which is high in view of the upcoming state and general election.
Sinha is principal economist and Pant is chief economist at India Ratings and Research (Ind-Ra). Views are personal