States debt-to-GDP ratio worryingly higher than FY23 target, says RBI report

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The combined debt-to-GDP ratio of states is expected to remain at 31 per cent by end-March 2022 which is worryingly higher than the target of 20 per cent to be achieved by 2022-23, according to a RBI report.

The Reserve Bank’s annual publication titled 'State Finances: A Study of Budgets of 2021-22' further said as the impact of the second COVID-19 wave wanes, state governments need to take credible steps to address debt sustainability concerns.

"The combined debt to GDP ratio of States which stood at 31 per cent at end-March 2021 and is expected to remain at that level by end-March 2022, is worryingly higher than the target of 20 per cent to be achieved by 2022-23, as per the recommendations of the FRBM Review Committee,” it said.

In view of the pandemic induced slowdown, in its projections, the 15th Finance Commission expects the debt-GDP ratio to peak at 33.3 per cent in 2022-23 (in view of the higher deficits in 2020-21, 2021-22 and 2022-23), and gradually decline thereafter to reach 32.5 per cent by 2025-26.

The RBI report noted that the budgeted consolidated gross fiscal deficit (GFD) of 3.7 per cent of GDP for states for the year 2021-22 – lower than the 4 per cent level as recommended by the FC-XV (15th Finance Commission) reflect the state governments’ intent towards fiscal consolidation.

According to the report, in the medium term, improvements in the fiscal position of state governments will be contingent upon reforms in the power sector as recommended by FC-XV and specified by the Centre – creating transparent and hassle-free provision of power subsidy to farmers; preventing leakages; and improving the health of the power distribution companies (DISCOMs) by alleviating their liquidity stress in a sustainable manner.

"Timely payments of state dues to DISCOMS and, in turn, by them to Generation Companies (GENCOS) hold the key to the sector’s financial health,” it said.

The report said undertaking power sector reforms will not only facilitate additional borrowings of 0.25 per cent of GSDP (Gross State Domestic Product ) by the states but also reduce their contingent liabilities due to improvement in financial health of the DISCOMs.

It pointed out that in 2020-21, the first wave of the pandemic posed states the critical challenge of declining revenue and the need for higher spending.

To partially offset the revenue shortfall, the report said states hiked their duties on petrol, diesel and alcohol and focused on rationalising non-priority expenditures to make room for higher expenditure on healthcare and social services.

According to the report, the year 2021-22 started on a similar note, with the outbreak of the second wave.

"However, the impact of the second wave on state finances is likely to be less severe than the first wave due to less stringent and localised restrictions imposed this time as opposed to the nationwide lockdown during the first wave of COVID-19,” it observed.