Debt burden of State Governments remain considerable: ICRA

ICRA Ratings has come out with its report on debt burden of State Governments. According to the rating agency tax revenues are expected to expand at a moderate pace in 2011-12, which may dampen the pace of growth of RR relative to the BE for 2011-12.

Debt burden of State Governments remains considerable; however, a back-ended repayment pattern would support liquidity in the medium term

The debt stock1 of Indian States has risen sharply in recent years, following a weakening of their fiscal health since 2008-092. This note discusses the trends regarding the relative debt levels of various States in India, the altered composition of their debt stock and the repayment pattern of the latter, focusing on the State Governments of Andhra Pradesh (AP), Gujarat, Karnataka, Maharashtra, Punjab and Tamil Nadu (TN)-States in which ICRA has rated the debt instruments of a number of Government entities.

Following the recommendations of the Twelfth Finance Commission (TwFC), the Central Government disintermediated from the borrowings of State Governments from 2005-06 onwards, resulting in a sharp decline in the inflows of loans from the Centre in the subsequent years. Loans from the National Small Savings Fund (NSSF) formed a substantial source of funding between 2003-04 and 2006-07, declining substantially thereafter. As a result, State Governments have increasingly contracted market borrowings in the form of State Development Loans (SDL) from 2007-08 onwards. Consequently, the composition of the debt stock of the States in the ICRA sample has altered considerably between 2004-05 and 2009-10, with a rise in the proportion of SDL, a marginal decline in the proportion of loans from the NSSF and a considerable decline in the share of loans from the Centre.

The long tenure of loans from the NSSF (25 years, with repayment to be made in 20 equal instalments from the sixth year onwards), results in limited redemption pressure. Although SDLs have a shorter tenure of 10 years, given that substantial funds were raised through this source from 2007-08 onwards, the redemption pressure is likely to be relatively low until 2017-18. Hence, the maturity profile is fairly back-ended across the States, which is a positive from the liquidity perspective in the medium term.

ICRA's expectations regarding the debt levels of the Indian States etc. in the near-to-medium term are as follows:

• Performance on various leverage indicators is likely to be somewhat inferior to the Budget Estimates (BE) for 2011-12 on account of a modest expansion of tax revenues, which is likely to dampen the growth of overall revenue receipts.

• Notwithstanding some improvement in certain leverage indicators, Gujarat and Punjab are likely to remain more indebted than the other States in the ICRA sample. Nevertheless, the magnitude of their debt stock at an absolute level is likely to remain smaller than other States, particularly Maharashtra and AP.

• Given the modest anticipated inflow of funds under the NSSF and the likely moderation in tax revenues in the current fiscal relative to the BE for 2011-12 , issuances of SDLs are likely to remain substantial in February-March 2012.

• The anticipated easing of policy rates from Q1, 2012-13 onwards would increase the attractiveness of various small savings schemes thus boosting NSSF inflows.

• However, with the planned reduction in the minimum share of States in the net small savings collections to 50% from 80% at present, the magnitude of funds to be raised by State Governments through SDL is likely to remain large in 2012-13.

Trends in 2011-12 and Outlook for 2012-13

The BE for 2011-12 published by the States in the ICRA sample forecast a secular improvement in the performance on various indicators (Debt/RR, Debt/SOTR and Interest Payments/RR) relative to the respective levels in 2009-10. Nevertheless, Gujarat and Punjab are likely to remain relatively more indebted within the sample; the debt stock of these two States is expected to remain in excess of 2 times RR, even though at an absolute level, the magnitude of their debt stock is likely to remain smaller than other States, particularly Maharashtra and AP. Moreover, in 2011-12, the interest payments of Gujarat and Punjab would continue to exceed 15% of RR, the target that had been set by the TwFC for 2009-10.

The broad trend of improvement in the indebtedness levels is aided by the high growth of RR and SOTR forecast by the States in the RE for 2010-11 and/or the BE for 2011-12. The CAGR for revenue receipts for the two years ending 2011-12 (according to the BE for 2011-12) remains substantial, particularly for Punjab (33%), as compared to a moderate 17-18% for Karnataka and Maharashtra. ICRA expects tax revenues to expand at a moderate pace in 2011-12,2 which may dampen the pace of growth of RR relative to the BE for 2011-12. Accordingly, the performance on leverage indicators may be somewhat inferior to what is suggested by the BE for the current fiscal.

In 2012-13, the anticipated easing of policy rates18 would result in an easing of Bank deposit rates (as well as the yields at which fresh SDL are contracted) and may result in an upswing in NSSF inflows if the rates of various schemes remain unchanged. However, with the planned reduction in the minimum share of States in the net small savings collections to 50% from 80%, the magnitude of funds to be raised by the State Governments through SDL is likely to remain significant in 2012-13.

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