Indian states’ outstanding liabilities rise 43% since pandemic, ringing alarm bells

Indian states are climbing a fiscal cliff with no end in sight. Data shared by the ministry of finance during the budget session of parliament shows that the outstanding liabilities of 28 states are projected to rise 43 percent in the three years from March 2020 to March 2023.

In all, the outstanding liabilities of all these states are forecasted to reach Rs 75 lakh crore by the end of the current financial year, up from Rs 52 lakh crores in March 2020 when the Covid-19 pandemic had forced a nationwide lockdown in India.

States’ finances have come under the spotlight recently amid a raging debate over freebies or pre-election doles by political parties. Several states have also moved back to the so-called old pension regime which guarantees defined returns for retiring government employees.

Meanwhile, India’s central bank continues waging a battle against inflation that seems to be getting entrenched. To this end, it has raised interest rates sharply from the record lows of the pandemic era.

The Centre’s borrowing is also projected at a record high in the next financial year even as it aims to lower the fiscal deficit as a percentage of gross domestic product.

Reason for worsening of states’ liabilities

States’ outstanding debt has shown a gradual upward movement due to implementation of Ujjwal DISCOM Assurance Yojana, farm loan waivers, pandemic-related revenue losses, additional expenditures and growth slowdown, the ministry of finance said February 7.

To be sure, the states have been regularly servicing their debt obligations and have typically not been punished much by a bond market that generally charges a spread of 50-100 basis points for state debt wider than the central government debt.

India’s federal structure allows states to tax but their borrowing capacity is defined by the Centre.

All States have also enacted their Fiscal Responsibility and Budget Management (FRBM) Act, with the compliance being monitored by the respective state legislatures.

The Ministry of Finance generally follows the fiscal limits mandated by the accepted recommendations of the Finance Commission while approving borrowings by states. The normal Net Borrowing Ceiling of each state is fixed by the Union Government in the beginning of each financial year. Adjustments for the over-borrowing during previous years, if any, are made in the borrowing limits of subsequent year.

Worst and best

In the tally of states that have seen the most rise in their outstanding liabilities are Madhya Pradesh (79 percent), Assam (65 percent), Rajasthan, Sikkim, Tamil Nadu (63 percent each).

Odisha, on the other hand, has managed to lower its liabilities between March 2020 and March 2023, by 21 percent!

Odisha, Maharashtra, Gujarat are the only states with the debt-to-GSDP ratios of up to 20 percent.

Impact

States will continue to be fiscally constrained even if they lower their borrowings in the coming years or, in fact, borrow less than projected amounts from the debt market.

As as result, the general government debt (Centre plus states) will remain high, forcing investors to demand higher returns for the bonds they buy.

This would, in turn, keep market interest rates elevated for longer, hurting  consumption and fresh investments.

It is high time for states to start taking corrective actions.