The central government is mulling redesigning its flagship 50-year interest-free loans scheme to stop instances of states relying on this assistance from the Centre to meet their capital expenditure requirements and not utilising their own funds.
"We are looking into how we can ensure better utilisation of the capex loans by states while at the same time ensuring that states use their own funds too for capex. We can change the design of the loans only for states that are not doing their own capex and relying on these loans,” a finance ministry official told Moneycontrol.
The Centre has been concerned about states relying heavily on revenue expenditure at the cost of ignoring spending on infrastructure, especially to fund populist freebies ahead of key elections.
Specifically, the finance ministry is worried that the special assistance from the Centre, which guarantees interest-free loans to states for infrastructure spending may be further discouraging them from utilising their own funds for capex.
“Capex state loans we have to rethink, especially for states that are supplanting capex loans with their own capex. We are identifying those states,” the official said.
A second government official said Andhra Pradesh, Rajasthan, Bihar, Jharkhand, Madhya Pradesh, Himachal Pradesh, West Bengal, Uttarakhand, and several north-eastern states have relied more on the interest-free loans from the Centre compared to their own funds for carrying out capex during the last three years.
In the wake of the pandemic that upended fiscal goals and spending targets, the finance ministry rolled out a scheme to provide financial assistance to states for capex in 2020-21 to boost expenditure on infrastructure.
Notably, a large part of the capex loans provided to states is already tied to reforms in areas such as industrial growth stimulation, infrastructure project completion, and land reforms.
For the current financial year, the outlay for the 50-year interest-free loans to states for capital expenditure has been pegged at Rs 1.5 lakh crore.
Debt-to-GDP concerns
What has been especially concerning for the Union finance ministry is the impact of capex loans on the debt levels of smaller states.
“Capex loans to states are renewed every year, but see the impact of it on smaller states on their debt-to-GDP ratio. Big states can absorb this, if we keep giving Rs 1.5 lakh crore every year then see what it does to their debt levels,” the first official said.
The second official added that the Seven Sisters, a term for the states of Arunachal Pradesh, Assam, Meghalaya, Manipur, Mizoram, Nagaland and Tripura, have largely limited their spending on infrastructure to the capex loans provided by the central government.
“The original intent of capex loans to states was that it has to top up their capex. If a small state gets something every year, but since it is shown as a loan on its books, it would impact its debt-to-GDP ratio. They have substituted their own capex with capex loans,” the first official added.
Economists too have pointed out that most states are expected to rely heavily on revenue spending thanks to several cash transfer schemes and welfare programmes they announced in the run-up to elections.
States in debt
According to a study by the National Council of Applied Economic Research released in February, more states may cross the 40 percent debt-to-GDP level by 2027-28, with Punjab likely to exceed the 50 percent mark in a business-as-usual scenario.
The Fiscal Responsibility and Budget Management (FRBM) Act recommends a combined debt-to-GDP ratio of 60 percent, with 40 percent for the central government and 20 percent for state governments.
As per data shared by the second official, in the last three years (FY23, FY24 and FY25) Punjab, Puducherry, West Bengal, Arunachal Pradesh, Kerala, Jharkhand, Odisha, Andhra Pradesh, and Karnataka have spent less than 6 percent of their total expenditure in capex.
Concerns around the rising debt levels of states, owing to the prioritisation of revenue expenditure over capex, come at a time when the Centre’s decision to adopt the debt-to-GDP ratio as a fiscal anchor from FY27 has raised hopes for a sovereign rating upgrade.
However, since international rating agencies look at the overall debt levels, efforts are underway to nudge states to follow suit.
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