Five states, namely, Bihar, Kerala, Punjab, Rajasthan, and West Bengal, figure among the most stressed states fiscally, as per a Reserve Bank of India article.
The RBI conducted a detailed study of the states’ finances following the recent Sri Lanka crisis. The RBI in its study has concluded that the finances of the states have deteriorated sharply owing to the Covid-19 pandemic.
States’ tendency towards handing out cash subsidies, provision of free utility services, revival of the old pension scheme, and extension of implicit and explicit guarantees have put states in a peculiar position.
Fiscal position & debt levels
RBI has determined that the average GFD-GDP ratio (gross fiscal deficit to nominal GDP ratio) of the states remained modest at 2.5% during 2011- 12 to 2019-20. This is lower than the Fiscal Responsibility Legislation (FRL) ceiling of 3%.
But then the pandemic hit, and the states’ fiscal positions deteriorated sharply in 2020 with a sharp decline in revenue, an increase in spending, and a sharp rise in debt to GSDP ratios.
The debt-GSDP (gross state domestic product) ratio is projected to moderate between 2021-22 and 2026-27, RBI says. It has attributed the moderation in the ratio primarily to the stellar fiscal performance of Gujarat, Maharashtra, Delhi, Karnataka, and Odisha.
RBI expects Punjab to remain in the worst position, with its debt-GSDP ratio projected to exceed 45% in 2026-27, while Rajasthan, Kerala and West Bengal are projected to exceed 35%.
These states will need to undertake significant corrective steps to stabilise their debt levels, the RBI has said.
High debt & freebies: Poor spending priorities?
Punjab, Rajasthan, Kerala, West Bengal, Bihar, Andhra Pradesh, Jharkhand, Madhya Pradesh, Uttar Pradesh, and Haryana are the states with the highest debt burden in India.
These 10 states account for around half of the total expenditure by all state governments in India.
When it comes to expenditure, states like Rajasthan, West Bengal, Punjab and Kerala spend around 90% on revenue accounts. The impact of revenue expenditure on economic activity lasts for about a year. These states have high revenue spending to capital outlay ratios.
Capital outlays have a longer-lasting impact on economic activity, with the peak effect materialising after two-three years.
In the medium to long term, states with high revenue spending and low capital investment may experience slower revenue growth and higher interest outgo.
Data shows Gujarat, Punjab and Chhattisgarh spend more than 10% of their revenue expenditure on subsidies, which are known to crowd out resources from other useful purposes.
Freebies, which include free electricity, water, public transportation, and farm loan waivers, potentially undermine credit culture, distort prices through cross-subsidisation erode incentives for private investment, and disincentivise work, the RBI said.
Providing free electricity and water is known to accelerate environmental degradation and depletion of water tables.
Course correction needed
The fiscal conditions among states in India are showing warning signs of building stress, the RBI notes.
“The slowdown in own tax revenue, a high share of committed expenditure and rising subsidy burden have stretched state government finances exacerbated by COVID-19. For the five most indebted states, the debt stock is no longer sustainable, as the debt growth has outpaced their GSDP growth in the last five years,” it said.
“New sources of risks have emerged – a relaunch of the old pension scheme by some states; rising expenditure on non-merit freebies; expanding contingent liabilities; and the ballooning overdue of DISCOMs - warranting strategic corrective measures,” the RBI added.
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