Home / Opinion / Columns /  The states must get their fiscal act together

Central bankers driving the current round of monetary tightening in the world are looking askance at fiscal laxity, which could grow the inflation disease even as monetary medicine is being applied. How are we in India doing on the fiscal front?

The Centre’s budgeted fiscal deficit for 2022-23 at 16.6 trillion, was 6.4 % of gross domestic product (GDP) as then projected, but 6.2 % of the likely GDP for 2022-23 of 269.5 trillion (first-quarter figures for this fiscal year notwithstanding). Aggregate state borrowing was set at 3.5 % of GDP by the Fifteenth Finance Commission (FFC), with an extra 0.5 % for power-sector reforms. Even if only 60 % of that added offer is reached, a state aggregate deficit of 3.8% added to 6.2 % at the Centre is a consolidated deficit of 10% (pre-Ukraine).

That is large, but manageable as long as no other back-door borrowing outside the budget is financing government expenditure. As it happens, off-budget borrowings had indeed grown alarmingly since 2016-17 at the Centre, but were (largely) brought on-budget in 2020-21. The timing of that on-shoring in pandemic year 2020-21, when so many other revenue and expenditure magnitudes had gone off-kilter, was totally brilliant.

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At the level of states, it is a different story. They too have indulged in off-budget borrowing going back much before 2016-17, but these have not been brought on-budget so far. In March 2022, the finance ministry at the Centre notified states that their off-budget borrowing during 2022-21 and 2021-22 (the first two years of the FFC period) would have to be brought on-budget during 2022-23 and deducted from their FFC entitlement for the year. These actions by the Centre are permissible under Article 293(3) of the Constitution. States’ new borrowing will therefore be lower than their total permissible limit of 3.5%.

Lower by how much? There should in principle have been a listing in state budget papers of government borrowings done through state-level public sector undertakings (SPSUs) at the very least, but no aggregate is readily available. Ananth Narayan, in a research note for the Observatory Group, innovatively estimates the off-budget overhang through the excess of budgeted over actual revenue expenditure. That excess by states in the past two years stands at 7 trillion. His estimation procedure uncovers more than just SPSU borrowings, which are done only for major schemes (like borrowings by Food Corporation of India at the Centre). It also covers the running up of payables through the practice of delayed payments to vendors, eventually paid in subsequent years by delaying other payments due. This form of borrowing from a miscellaneous, shifting body of hapless compulsory lenders, has probably grown over time.

But since states also deal with unmet expenditures by the simple device of axing smaller schemes which don’t matter from an electoral viewpoint, instead of borrowing, the estimate does overstate off-budget borrowings. Even if the stock is estimated at 6 trillion, that is still 2.2% of GDP, which would leave states with new borrowing of just 1.3% of GDP out of their permissible total of 3.5%. Since that is clearly untenable, the finance ministry announced recently that on-shoring will be staggered over the remaining four years of the FFC period, up to 2025-26.

Left uncovered are off-budget borrowings by states before 2020-21 hanging outside the budget (another 7.5 trillion between 2016-17 and 2019-20). And it leaves out two other severe fiscal threats at state level.

One is pensions, where the transition towards a defined contribution system has not gone well at the state level. In a recent notification, the finance ministry has permitted additional borrowing for states to incentivize that transition. But this alone will not suffice. Some re-structuring of the new system is needed, or else states will slide back to the earlier defined benefit system with wage indexation, a uniquely Indian and fiscally disastrous feature.

The other is the dire state of the power sector, which falls within the jurisdiction of states under the Constitution. Power distribution companies (Discoms) are unable to pay off their suppliers (Gencos), because of unreformed tariffs. States promise compensating subsidies to Discoms, which provide partial cover at best, and are often never paid. Discoms cover their losses by borrowing from public sector banks, or, more recently, from non-bank financial intermediaries like the Power Finance Corporation (PFC). These loans are either explicitly or implicitly underwritten. Alternatively, Discoms just run up payment arrears to Gencos, currently estimated at 1 trillion.

In a recent crackdown on 18 August, the ministry of power barred access to 13 states with immediate effect from power exchanges where they buy their power, until they had cleared their current bills to Gencos, amounting to 5,100 crore. A June notification laid out a payment and penalty schedule for unpaid arrears to Gencos in up to 48 equal monthly instalments. Since further loans even from the PFC are unlikely to be forthcoming, this payment of arrears will have to be funded by states.

And finally, there’s the post-Ukraine additionality to the Centre’s fiscal deficit—of roughly 1% of GDP. These are testing times.

Indira Rajaraman is an economist.

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