Fiscal deficit: Cabinet approves states' targets in line with 14th Finance Commission report

The report also suggested year-to-year flexibility for additional deficit of about 0.5%, plus or minus

The Cabinet on Wednesday approved the fiscal deficit target of three per cent of gross state domestic product (GSDP) for states for the 2015-20 period, as recommended by the Fourteenth Finance Commission.

The FFC report also suggested year-to-year flexibility for additional deficit of about 0.5 per cent, plus or minus.

In its Action Taken Report on the recommendations, the government had said it would move forward on these at a later date, which it did on Wednesday.

The Cabinet approved the target with a flexibility option, according to an official statement. There is additional headroom to a maximum of 0.5 per cent over and above the normal limit of three per cent in any given year to states with a favourable debt to GSDP ratio and interest payments-revenue receipts ratio in the previous two years.

"Since the year 2015-16 is already over, states will not get any benefit of additional borrowing for 2015-16. However, the implications for the remaining period of the FFC award would depend upon respective states' eligibility, based on the criteria prescribed by FFC," went the statement.

There would be no financial implications for the Centre as the borrowings are made by states within the fiscal deficit limits laid down and incorporated in their respective Fiscal Resposibility and Budget Management legislations. States will get additional space to raise borrowings which mighty result in needed government expenditure for capital projects or infrastructure.

"This decision would incentivise states to take a more holistic view of their fiscal health, rather than the current relatively narrow focus on restricting the deficit below three per cent of GSDP," said Jayanta Roy of ratings agency ICRA.

If a state is not able to fully utilise its sanctioned fiscal deficit in any year, it may avail this unutilised amount only in the following year but within the FFC award period. Any additional borrowing beyond the entitlement would be adjusted from the net borrowing ceiling of the following year.

"The permission to carry forward any unutilised fiscal deficit amount to the following year (up to 2019-20) would impart flexibility to the states to time their borrowings in line with foreseeable expenditure spikes, for instance related to the pay commission awards. This is preferable to the current practice adopted by some states that choose to exhaust their borrowing limits each fiscal year, irrespective of the actual need, and park excess funds in lowering interest-bearing treasury bills," Roy added.

The cabinet decision gains significance in the backdrop of the states' issuing bonds under the UDAY scheme for power distribution companies' financial help. The decision will allow them to take on additional debt without stretching the deficit limits.