FY18 State Budgets: Continued Capex by State Governments Encouraging, but Farm Loan Waivers Could Destabilise Finances

The combined fiscal deficit of states averaged 2.16% during FY11-FY15, but came under pressure thereafter, says India Ratings and Research (Ind-Ra). This was firstly due to Ujwal Discom Assurance Yojna (UDAY) and subsequently due to the implementation of the recommendation of the Seventh Central Pay Commission. As a result, the combined fiscal deficit of the states in FY16 and FY17RE came in at 3.07% and 3.66% respectively. States issued UDAY bonds of INR989.6 billion in FY16 (0.72% of GDP) and INR1.10 trillion in FY17 (0.72% of GDP). Excluding the bonds issued, the combined fiscal deficit comes out to be 2.35% and 2.94% for FY16 and FY17RE, respectively.

Fiscal Deficit to be Higher than Budgeted: The combined fiscal deficit of states for FY18 has been budgeted at 2.7% (INR4.48 trillion) of GDP. Nine states have budgeted for an increase in their fiscal deficit/gross state domestic product (GSDP) ratio in FY18 compared to 19 states in FY17 (RE). However, with several states announcing farm loan waivers, there is a fear that the combined fiscal deficit of states could be much worse than the budgeted figure. Ind-Ra's estimate shows that the combined fiscal deficit of states in FY18 would come in at 3.0% of GDP (INR4.99 trillion). This is higher than the budgeted figure but considerably lower than FY17RE. Ind-Ra's estimate is based on the analysis of 29 state budgets, the impact of the farm debt waivers announced outside state budgets and implementation of GST from 1 July 2017.

 

The farm debt waivers announced by five states together are likely to widen the combined fiscal deficit of states by INR1,077 billion (0.65% of GDP). This is marginally lower than the impact of UDAY scheme on the combined fiscal deficit 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 to fund farm debt waivers or cut FY18 budgeted expenditure. Ind-Ra has observed that if such announcements are funded through expenditure compression, the axe usually falls on firstly budgeted capital expenditure, followed by social expenditure. Both cuts are not augur well from the point of view of the medium to long term growth prospects of the state.

Andhra Pradesh and Telangana, which announced a farm debt waiver of INR430 billion and INR170 billion, respectively, in 2014, however have adopted a staggered payment mechanism. They rolled over the announced farm debt waivers over four years with the last instalment due in FY18. This definitely helped these states minimise the fiscal risk associated with such decisions and manage the finances better.

As higher fiscal deficit in FY16 and FY17 due to UDAY would exert pressure on interest payment, interest pay-out for FY18 has been budgeted to increase to 1.76% of GDP from 1.69% in FY17 (RE). Besides the higher interest pay-out, the other component that will increase the committed expenditure of state governments is the salary revisions after the implementation of the recommendations of the Seventh Central Pay Commission. The share of selected committed expenditure (salary, pension and interest) in revenue expenditure, therefore, has been budgeted to increase to 48.34% in FY18 from 46.93% in FY17 (RE).

Fiscal Pressures, No Threat yet to Debt Sustainability: Despite these fiscal pressures, the encouraging feature of FY18 state budgets is near stability in the combined revenue deficit and some improvements in the combined primary deficit of the states compared to FY17RE. Although FY18 budgeted figures for combined revenue and primary deficit of states are 0.04% of GDP and negative 0.93% of GDP, Ind-Ra's estimate pegs them at negative 0.26% of GDP (FY17RE: negative 0.23% of GDP) and negative 1.23% of GDP (FY17RE: negative 1.97% of GDP), respectively.

Although a decline in primary deficit/GDP ratio augurs well for debt sustainability, the combined state debt/GDP ratio will rise to 24.79% in FY18 from 23.76% in FY17RE, according to Ind-Ra's estimate.

Capex by State Governments On Course: The other encouraging feature of FY18 state budgets has been the continuation of capex by state governments. Boosted by UDAY issuances, combined capex of states grew 40.0% yoy and 26.2% yoy in FY16 and FY17 respectively. In fact, the combined capex/GDP ratio breached the 3.0% mark in FY16. However, excluding UDAY issuances, the combined capex grew 7.2% yoy and 30.9% yoy in FY16 and FY17, respectively. It has been budgeted to grow 19.3% and would be 3.0% of GDP in FY18.

Ind-Ra believes that the stress emanating from UDAY and salary/pension revisions so far has been absorbed adequately and with relatively little damage to state finances and their debt sustainability. However, the same cannot be said about farm loan waiver if it continues and spreads to other states. The probability of this is high in view of the upcoming state elections and general election in 2019. Debt waiver of only five states is 0.65% of GDP in FY18.

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