How UDAY and pay revision are restricting Rajasthan's fiscal space

Limited fiscal room has led to the state cutting back on capital outlay and social sector spending

When a temblor strikes a place, it would be a great mistake on the part of the affected not to prepare for the aftershocks. The case of Rajasthan’s state finances is similar.

In 2015-16, the state government took over the loans of power distribution companies (discoms) under Ujwal DISCOM Assurance Yojana (UDAY). This resulted in a sharp increase in its interest burden. Add to this the rise in its expenditure on account of the revision in salaries of government officials and the decision to waive farm loans to the tune of Rs 80 billion, and the fiscal space got severely restricted. As a result capital spending and social sector spending suffered. 

The lingering impact of UDAY

The state government took over loans of power distribution companies (discoms) worth Rs 390 billion between 2015-16 and 2016-17 under Ujwal DISCOM Assurance Yojana (UDAY). 

While the discom debt was earlier guaranteed by the state government, it got converted into an actual liability after this transfer, adding to the state’s debt. As a result the state’s debt rose to 33.6 per cent of GSDP in 2016-17, from 24.1 per cent in 2014-15. 

Including the UDAY bonds, the state’s fiscal deficit shot up to 9.2 per cent of its gross state domestic product (GSDP) in 2015-16, from 3.1 per cent in 2014-15. In 2016-17, it stood at 6.1 per cent. The deficit in 2015-16 was the highest among all states that year, and highest for any big state in the recent past. 
 

Even after removing the fiscal impact of UDAY—since it is ‘quasi-fiscal’ spending as some economists put it—the fiscal deficit stood at 3.4 per cent of GSDP in 2015-16 and 2016-17, climbing up marginally to 3.5 per cent in 2017-18 (revised estimate). 

Rajasthan’s fiscal deficit in 2018-19 is budgeted at three per cent, lower than that in the previous year, but higher than the all-state average of 2.6 per cent. 

However, if the past record is anything to go by, budgeted targets are rarely achieved. States tend to overestimate revenue receipts as a consequence of which the fiscal deficit is breached, various studies have shown. 

Rajasthan’s fiscal deficit could remain above four per cent till 2021-22, according to a study by Pinaki Chakraborty on the impact of UDAY on Rajasthan’s state finances in Economic and Political Weekly. 

“Though Rajasthan’s finances appeared compliant to the Fiscal Responsibility and Budget Management (FRBM) Act without the power liabilities, UDAY has made it clear that a comprehensive view is necessary to understand the downside fiscal risk arising out of quasi-fiscal activities by states,” the report said. 

As a consequence of this rise in debt burden, the ratio of interest payments to the state’s own tax revenue rose from 28 per cent in 2015-16 to as much as 40 per cent in 2016-17, and has remained elevated at similar levels in the 2018-19 budget estimate. 

The spike in the interest payouts in the subsequent years, as a result of this one-time debt burden, will continue for years to come. 

A point must be noted here is that the own tax revenues after 2017-18 cannot be directly compared with previous years due to the non-clarity and irregularity in the reporting of Integrated Goods and Services Tax (IGST) revenues. 

Pay commission impact 

Rajasthan also started paying out higher salaries to government employees, as mandated by states’ revised pay commission rules in October 2017. As a result, salaries began accounting for a bigger chunk of the state’s revenue expenditure. 

In fact, the state’s wages and salaries expenditure grew about 30 per cent in 2017-18 over the previous year, faster than the 22 per cent growth in overall revenue expenditure, according to the RBI report on state finances. 

In addition to this, the stabilisation in salaries post pay revision and payment of arrears would be over only by 2020-21, says the report. Thus the impact of pay revisions, too, would not be one-off, but would get reflected in the medium term. 

Limited fiscal space restricts spending 

As a direct result of these fiscal pressures, Rajasthan’s capital outlay—the spending on productive assets—actually declined from Rs 220 billion in 2015-16 to Rs 170 billion in 2016-17, and improved marginally to Rs 225 billion in 2017-18. 

Capital outlay was 3.2 per cent of GSDP in the UDAY implementation year of 2015-16. In subsequent years, it went down to 2.2 per cent of GSDP in 2016-17, and is expected to remain at 2.8 per cent of GSDP in 2018-19, courtesy interest payments and pay revisions. 

In its struggle to maintain the fiscal position, social sector spending -- specifically on health and education -- has remained more or less unchanged during the current government’s term. Health and education spending suffered a notice setback in 2015-16 due to UDAY as the chart shows. 

Rajasthan goes to polls in November or December 2018 if the poll calendar runs the normal course. The challenge before the new government that takes charge later in 2018 will be embracing the second-order effects of these changes.