States' debt swap mooted

12th Finance Commission mulls parachute plan to bail out states

The Twelfth Finance Commission (TFC) is considering a debt restructuring package on the lines of what the Ninth Finance Commission (NFC) offered to the states. It could extend the repayment period of state debt in order to provide states with breathing room on the fiscal front.

This option would be preferable to cancelling state debt. A write-off, while improving the states' deficit, would lead to worsening deficit at the Centre, unless there is a concurrent reduction in the transfers made to the states by the Finance Commission.

"While write-off is not an option, lowering interest rates and stretching the repayment period is equivalent to reducing the debt burden," Montek Singh Ahluwalia, Deputy Chairman, Planning Commission told Business Standard. The Planning Commission is in charge of plan fund disbursements, while the Finance Commission makes non-Plan allocations to states.

Cancelling debt would also not be possible given the central government's commitment under the Fiscal Responsibility and Budget Management Act (FRBM),2003, which requires it to eliminate revenue deficit by 2007-08.

The NFC had suggested the rescheduling and write-off of certain loans outstanding against state governments and the elongation of the maturity period of future central loans for state Plans from 15 years to 20 years with 50 per cent loans enjoying a grace period of 5 years.

"The issue of debt management was largely ignored by the Tenth and Eleventh Finance Commissions and the TFC would have to tackle the issue," said NJ Kurien, Principal Consultant at the National Institute of Public Finance and Policy (NIPFP).

The debt levels of a majority of states is unsustainable and they need assistance to overcome their deficit problem. The TFC, which is chalking out a debt restructuring plan, is expected to submit its report by December. The Planning Commission would then address the issue in the mid-term appraisal of the Tenth Five Year Plan.

States are increasingly financing expenditure through debt. Interest burdens are squeezing expenditure and what remains is used to pay pensions and salaries, Ahluwalia said, adding that the Plan was financed largely through borrowings.

"The ability of states to service debt is in question and the Finance Commission is looking at the issue," he added.

West Bengal, for instance, has an annual interest liability of around Rs 10,000 crore ,while its total tax revenue is approximately Rs 12,000 crore. A number of North-Eastern states have debt burdens exceeding their total tax and non-tax revenues, Kurien said.

In the Budget for the current fiscal, the government has extended the facility of debt swap by allowing the states to raise fresh loans and repay their old high-cost loans to NABARD and some other agencies.

States are also being consulted on the issue of allowing them to increase their open market borrowings and reducing their dependence on loans from the Centre.