State Debt ‘Just About Sustainable’, Argues RBI Paper

A Reserve Bank of India working paper argued that state level debt in India is “just about sustainable” and limits set for it under the ‘Fiscal Responsibility Legislation' may need to be reviewed.

The paper, which does not take into account the impact of Covid-19 on state government finances, said the UDAY power reforms scheme of 2016-17 has been a big factor in pushing up state level debt.

“States' debt is just about sustainable with some potential signs of unsustainability. Guarantees given by states, if invoked, could certainly pose a potential risk to debt sustainability for Indian states,” the paper said. “The clear policy implications that emerge from the paper include the need to revisit and review states' FRLs with the inclusion of debt as a medium-term anchor, coupled with greater transparency with regard to contingent liabilities/ off-budget borrowings.”

Rise In Debt Higher Than Nominal GDP Growth

According to the paper, unlike in the case of the central government, states' debt is increasing at a double-digit rate, at a pace higher than nominal GDP growth.

While state debt ratios were on a declining trend between 2002 and 2003 till about 2015-16, the implementation of the Ujjwal Discom Assurance Yojana led to a sharp increase. Under the scheme, states were required to take on 75% of the debt of their individual discoms over a two-year period.

“After the implementation of the UDAY scheme, states' debt recorded a sharp increase in 2015–16 and 2016–17 to around 25% of GDP. The expenditure pressures on account of large committed expenditures and schemes like farm loan waivers also contributed to the recent rise in states' debt,” the paper said.

The debt-to-GDP of a number of states is now higher than the 25% prescribed by the Fourteenth Finance Commission. An FRBM Review committee had suggested 20% as the limit of state debt-to-GDP by 2023. Most states are above that limit, the paper said.

Another area of concern highlighted in the paper is that the level of sub-national debt in India is higher than in other countries.

While India's sub-national debt stands at 24.8% of GDP, for China the headline debt stands at 20.6%. But if off-budget liabilities are added, China's sub-national debt would rise to over 50% as of 2017.

Still, India's sub-national debt is higher than most other BRICS economies, the paper said.

The Question Of Guarantees

The paper also highlighted the need to improve reporting of guarantees, which are generally not reported explicitly by state governments in their budget documents. Data from the Comptroller and Auditor General on such guarantees comes with a lag.

States have been relying more on guarantees to push out expenditure onto the books of state-owned enterprises and agencies. “The support through guarantees is driven by the necessity to meet the requirements of financing infrastructure with the limited fiscal space available to the states,” the paper said, adding that such guarantees allow state enterprises to borrow at cheaper rates in the market.

Time For A Review?

The paper goes on to argue that a review of the current fiscal rules governing states may be in order.

In particular, debt should be added as a policy variable along with fiscal deficit, just like in the case of the central government, it said. The performance of state-owned public sector enterprises must also be reviewed from time to time and a framework for guarantees must be put in place.

“Laying down a transparent institutional mechanism may ensure that states meet their debt-deficit targets,” the paper said.