States’ Fiscal Deficit on the Rise

The fiscal deficit trends in the country have shown a stark reversal and the situation is expected to get worse in the near future. Comparing with the earlier trends, states were more fiscally prudent until about three years ago than the Centre and are now having bigger deficits and facing financial difficulty in this financial year. With three key pressure points, this fiscal could be worse due to these reasons:

  1. Spate of farm loan waivers across the states.
  2. Interest liabilities of states that have participated in UDAY Scheme for financial restructuring of electricity distribution utilities would increase going forward
  3. The effect of latest Supreme Court order on closure of bars along highways and rising prohibition efforts across some states. At least a dozen of the states are expected to see a substantial dip in state excise revenues from alcohol.

Analysis:

This trend is expected to continue. The more the states are in deficit, the more they will have to borrow from the market. In the process of cooperative federalism, Centre has given lot of rights to the State Governments in terms of expenditure. The quality or pattern of expenditure is not known most of the times. It has been seen in the past that mostly money is spent on capital expenditure and some of the revenue expenditures were taken care of by the central schemes and some by states themselves.

The direction of fiscal deficit gets set for the entire year once so, there is not much left to do in the middle of the year as a particular borrowing pattern has already been set by the states. Until the next Finance Commission reorganizes the state finances, situation seems unlikely to change.

GST numbers will now start showing up. Therefore, the states have to be very cautious about keeping their fiscal house in order. Because the states are borrowing more, the banking sector and the insurance sector will be dipping into this pool more. The corporate bond market might see hardening of rates because a state paper with a sovereign guarantee is a much more attractive paper for banking and insurance companies to dip into. There is a possibility of crowding out of private borrowing from the market.This means that in order to stay, the private sector will have to offer higher rate of interest. Overall economy will get into a slightly costly situation and therefore, states’ borrowing will certainly have an implication on economy.

When 7th Pay Commission comes in, burden will be much more on the states. There are somecompensations being given by GST Council to states for next 5 years, so it might be helpful to some extent.

Conclusion:

UDAY Scheme is necessary because it is important to bring the whole electricity burden onto the books. Future monetary policy, growth and expenditure will be affected if more states waive farm loans. Losses from liquor ban is being covered by imposing additional taxes over and above GST like in Maharashtra and Tamil Nadu. But this is not the way GST is supposed to work. Whether states are spending on developmental targets they have fixed for themselves has to be seen. The way ahead needs each of the states to be efficient with spending their money and reduce their liabilities.

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