Forget GDP, worry about the financial state of our states

DEBT BURDEN: UP’s debt is going to be a big challenge for the new CM, Yogi Adityanath
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For a government so focused on triumphal messaging and with the ‘3 saal bemisal’ celebrations reaching a crescendo, new economic numbers released this week make for sobering reading. Finance minister Arun Jaitley has pointed to the impact of global factors, vociferously asserting that 7-8% growth is the new normal and “fairly reasonable”. The government’s chief statistician TCA Anant thinks that slowdown concerns shouldn’t be overplayed just yet, that the economy is still growing rapidly even if “not as fast as we would have liked”. Yet, the trajectory of the numbers is clear: India’s GDP growth slowed down sharply in January-March this year to 6.1%, down from 7% in the previous quarter, and to a three-year low of 7.1% overall in 2016-17. While economists continue to debate the slowdown and whether the demonetisation gamble was responsible (no, says the government), what should concern us all even more is the declining financial state of our states.

While all attention has been focused on Modi sarkar, many of our states have been borrowing money like there is no tomorrow. Reserve Bank of India (RBI) recently reported that the debt-to-state GDP ratio of as many as 17 Indian states increased in the past year. For all states taken together, this ratio hit an alarming 3.6% in 2015-16 (breaching the mandated 3% ceiling under fiscal prudence rules) for the first time in 10 years. As RBI put it, “The consolidated finances of states has deteriorated in recent years…information on 25 states indicates that improvement in fiscal metrics budgeted by states for 2016-17 may not materialise.”

This matters because it is state governments that really control most things that touch us directly — from land, electricity and water to schools, hospitals and state highways — and when foreign investors see India they don’t just see the central government but the combined health of the Centre and the states.

So, which states have a real problem with managing their money? Uttar Pradesh is a big challenge for newly minted CM Yogi Adityanath, with its gross fiscal deficit to gross state domestic product ratio in 2015-16 going up to 5.6% (up from 3.1% the previous year). For Rajasthan, this ratio is a whopping 10% (up from 3.1%), Haryana 6.3 %(up from 2.9%), Bihar 6.9% (up from 3%), Madhya Pradesh 3.9% (up from 2.4%) and Goa 6.8% (up from 2.3%).
Why does this matter to anyone other than accountants? Crudely put, the more a state borrows, the more it must pay back each year with interest — somewhat like your annual house EMIs — leaving lesser money to spend on development spending. This partly explains why 17 major states in the current financial year, according to a study quoted in TOI this week, have budgeted for a 10.8% rise in spending (compared to 19% last year) making it the slowest pace of increase in 13 years.

In 2016, for example: UP, West Bengal, Punjab and Goa all had high outstanding liabilities of over 32% of their state domestic product. Data put out by RBI shows that none of these states managed to significantly ramp up their development expenditure over the past three years. West Bengal’s development spending has consistently hovered around the 7% mark, Punjab around 6% and UP roughly around 11%.

Four key points stand out. First, on the positive side of the ledger, of course, some of this increased state government debt is because of the stellar financial cleanup and revival of state electricity distribution companies by Piyush Goyal under his flagship UDAY scheme. Like Suresh Prabhu’s power cleanup in the Vajpayee regime, this has entailed state governments taking on the liabilities of their sick power distribution companies for a one-time solution to their financial mess. Nine states borrowed Rs 989.6 billion under UDAY in 2015-16. Without these bonds, state finances would have looked much better. In that sense, this can be seen as a temporary dip and state fiscal policies are sustainable in the long run.

Second, while states now get a bigger share of tax devolution from the Centre — 42% as opposed to 32% earlier — some of this gain has been offset by reductions in what they got under other plans.

Third, while states are getting more money, they are also spending more. UP’s Rs 30,729-crore scheme for waiving farmer loans is a case in point. It has led to a competitive scramble among other states: Punjab, Maharashtra and Karnataka are all mulling similar measures irrespective of whether they can afford them or not.

Fourth, state governments are now increasingly more dependent on market forces. Market borrowings, RBI says, constitute 69.7% of states’ outstanding liabilities in 2015, slated to go up to 74.7% in 2017. A lot of investor money is going into the states because who can imagine a state government defaulting?

Finally, the upcoming GST will significantly alter the whole system. It is the greatest tax reform in our country but it also means bracing ourselves for a further period of uncertainty in state finances.

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