As Covid pandemic hit states’ tax revenues, the Centre not only raised their borrowing limit by 2 percentage points to 5% of GDP in FY21 but also allowed them to borrow up to 75% of the annual threshold in April-December of the year.
The Centre will scrutinise each state’s off-budget liabilities before approving its borrowing limit for FY23. The regulation is in view of the rising yields on the state development loans (SDLs) and the rate hike cycle started by the Reserve Bank of India, which could raise the cost of general government borrowings.
As Covid pandemic hit states’ tax revenues, the Centre not only raised their borrowing limit by 2 percentage points to 5% of GDP in FY21 but also allowed them to borrow up to 75% of the annual threshold in April-December of the year. A similar relaxation was available in FY22 as well, while the limit was reduced to 4.5%. This time around, however, such front-loading of borrowings by the states will be allowed only under tighter scrutiny by the Centre, according to official sources. The states’ borrowing limit for the current fiscal year is 4% (see graph).
To ensure that states don’t over-borrow by understating facts, they have been asked by the Union finance ministry to provide detailed information on various liabilities. “Information has been sought on off-budget borrowings, guarantees being provided to state-run entities and whether contributions to the national pension system (NPS) are being deposited in time or not,” a senior official from the finance department of a state said.
Separately, finance secretary TV Somanathan wrote to chief secretaries of all states in April that All India Service officers (such as those in IAS) will face disciplinary action under their service rules if they submit wrong financial information to the Union government, another state government official said. The trigger for the letter was one state breaching its borrowing limit by providing wrong information to the Centre in a recent year, the source said.
The Centre hasn’t given its final approval for individual state’s borrowing plan for the current fiscal year so far, while in recent years, such approvals used to be granted in April itself. This also marks its intent to oversee the states’ borrowings in the current year more closely.
The Centre also reckons that given the increased revenue buoyancy, the fiscal stress on the states will be relatively less in the first half of the current fiscal, enabling many of them to go slow on borrowings.
The Centre’s own gross market borrowings in the current fiscal is pegged at Rs 4.95 trillion, compared with 10.47 trillion in FY22. It has announced that 60% of borrowings will be done in the first half of the year.
In the last two financial years, a regime of relatively low interest rates, instituted by the RBI, helped the Centre and states to rein in the cost of borrowings. Still, the debt burden of both the Centre and states have risen in last two years due to the sharp increase in borrowings. Revenue constraints, Covid-induced extra spending on welfare and elevated capital expenditure by the Centre necessitated higher budget deficits and thereby elevated borrowings.
The general government debt touched a 38-year high of about 89.4% of the gross domestic product in FY21, with Centre’s debt at 59% and states’ aggregate debt at 30.4%. A committee, which reviewed the fiscal responsibility parameters, had said the general government debt should be contained at 60%, with a 40% cap for the Centre and 20% for states.
States can’t borrow beyond the annual limits set by the central government under Article 293(3) of the Constitution. But states don’t need prior consent from the Centre to guarantee the loans and advances, and bonds issued by its entities. All these have also led to greater reliance on off-balance sheet borrowings by some states.
According to Crisil Ratings, off-balance sheet borrowings by all states may have reached a decade-high of about 4.5% of the GDP, or about Rs 7.9 trillion, in FY22. The off-balance sheet borrowings mark a rise of about 100 basis points from FY20, revealed the Crisil study of 11 states that account for about 75% of the aggregate GDP of the country. Around 4-5% of the revenue of states will go towards servicing such guarantee obligations this fiscal, partially reducing the ability of state governments to fund capital expenditure, it said.
The second state government official quoted above said the Centre is taking the nominal GSDP projected by the Fifteenth Finance Commission into account while deciding on the borrowing limit for each state. Accordingly, the FY23 aggregate untied borrowing window for states is seen to be in the region of `8.3 trillion, while another about `1.2 trillion borrowing is linked to power sector reforms.
Market borrowings by states may be relatively low in the initial months of this fiscal, thanks to the cushions of liberal Rs 1 trillion interest-free capex loan from the Centre, likely higher tax devolution than budgeted and release of GST compensation amounts till June 30.
After the RBI’s surprise hike in the repo rate by 40 basis points on Wednesday, the yield on 10-year central government securities (G-secs) yield closed at 7.38% on that day, a three year high. Analysts expect the benchmark yield could rise to 8-8.5% soon. The state development loans (SDLs) would typically be 50 bps costlier than the G-secs, although it varies significantly among states.
Even before the RBI’s rate action, SDL yields were hardening. On March 29, the weighted average cut-off of SDLs hardened by 18 basis points to a high 7.34% from 7.16% in the previous auction. On April 26, Punjab borrowed at 7.48% for 20-year SDLs while Andhra Pradesh raised at 7.52% for 20-year SDLs.