Give States Extra Fiscal Space to Reduce Off-Budget Commitments: Analysts

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The Center should allow states, most of which are facing revenue constraints after the pandemic, to run larger budget deficits to allow them to write off much of their growing off-budget liabilities, analysts said. .

While the Center completely halted project and program funding through extrabudgetary resources (EBR) in FY23, many states with high offbudget commitments were reluctant to take similar action due to income constraints.

According to a study by Crisil Ratings, off-balance sheet borrowing by state governments may have peaked at around 4.5% of GSDP, or around Rs 7.9 trillion in FY22.

The Center has recorded in its balance sheet off-budget liabilities worth about Rs 3.7 trillion on government programs such as food subsidy, fertilizer subsidy, housing and potable water during the pandemic years FY21-FY22 when rating agencies were more tolerant of widening budget deficits. Some residual off-budget debt remains, including on housing and drinking water projects, which will be cleared in due course, a senior central government official said. It also halted new borrowing by some semi-commercial entities such as NHAI, MTNL and BSNL from FY23 by providing increased budget support.

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To accommodate these course corrections, the Center allowed itself a budget deficit of a record 9.2 percent of GDP in FY21, 6.7 percent in FY22, and aims to reduce it to 4.5% by FY26, well above the prudential limit of 3%. The Center allowed a maximum budget deficit of 5% of the GSDP in FY21 and 4.5% in FY22 with a 75 basis point rider in each linked to the reforms. It is set at 4% of GDP with 50 basis points tied to power sector reforms to bring electricity distribution companies back to health.

The Center is rightly trying to tell states that they should also stop borrowing off-budget and run their affairs within budget deficit ceilings, said former Economic Affairs Secretary Subhash Chandra Garg. However, therein lies a small problem since states do not have the luxury of high budget deficits like the Center and are therefore constrained, he said. “Therefore, in my opinion, the Indian government should logically move that as long as the Indian government is running a high budget deficit, it should allow the states to also have a higher budget deficit and control or eliminate non-borrowing budget,” Garg said.

The Centre’s action to bring transparency into its budget gave it the moral authority to finally clamp down on the disorderly accumulated off-budget debts of many states.

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Thus, the Center has tightened mandatory borrowing approval for many states to exploit the market for issuing their state development loan documents by enforcing a 23 year rule that all Off-budget liabilities would be counted against their annual net borrowing limits (NBC).

It removed at least 25 basis points (bps) from the 3.5% gross state domestic product (GSDP) of these states in FY23. As a result, it cut 41,000 crore from rupees or 62% of the states’ total off-budget liabilities in FY22 their net borrowing ceiling for FY23, which would impact eight states including Telengana, Andhra Pradesh and Kerala.

Kerala had objected to the Centre’s decision to include loans from the Kerala Infrastructure Investment Fund Board (KIFB) in the state NBC, thereby reducing the funds available for the state budget. The KIFB, a government-backed legal entity, has been an effective tool in finding resources for state capital expenditures incurring high revenue shortfalls.

The Center also has an unfinished agenda on this front, such as extrabudgetary resources being mobilized by the Indian Railways Finance Corporation for railway projects, but analysts believe these are not pressing issues as these semi-commercial entities also have their own revenue-generating capacities and budget allocations for the railways have also increased significantly. While NHAI has a debt of Rs 3.49 trillion at the end of FY22, IRFC has provided around Rs 4 trillion of financing to the railway sector.

Unlike the Center, the revenue-generating capacity of most states is limited, which limits their ability to directly fund the entities they own. As state-run entities struggle to build social infrastructure and fund their governments’ welfare schemes, their cash flow is also constrained.

“Although it is a good decision to have control over government borrowing from a demand for funds perspective. by states, this will not only have an impact on the growth rate and fiscal position of states, but also on the achievement of social outcomes,” said DK Pant, Chief Economist at India Ratings.

According to NR Bhanumurthy, Vice Chancellor of BASE University, Bengaluru, states should follow what the Center is doing to improve their fiscal conditions. “Transparency always leads to better results. The Center has already created a sort of incentive structure by giving the possibility to states to carry out certain reforms to obtain an additional borrowing window,” Bhanumurthy said.

The Center’s ballooning deficit in FY21 pushed its debt-to-GDP ratio to also hit a 14-year high of about 59% (vs. the prudential level of 40%) in FY21 and will be probably above 55% in FY22. Aggregate government debt reached a 15-year high of 31% of GDP (the prudential level at 20%) in FY21 and appears to be a little lower than in FY22, as improved revenues helped them reduce borrowing.

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