Unlikely to Destabilise Aggregate State Finances but Select States Will Feel the Pinch

Ujwal Discom Assurance Yojana (UDAY) is unlikely to have a destabilising effect on fiscal consolidation at an aggregate level, says India Ratings and Research (Ind-Ra). Ind-Ra's estimate shows that the aggregate fiscal deficit of states at 3.2% of GDP in FY17 is expected to be marginally better than the 3.4% recorded in FY16 (revised estimates (RE)). The aggregate impact of UDAY on the fiscal deficits of the 13 states that have joined UDAY till date will be 0.47% of gross domestic product (GDP) in FY17.

However, state finances of select states namely Andhra Pradesh, Haryana, Jharkhand, Punjab, Rajasthan and Uttar Pradesh will come under pressure. Five states incurring high distribution losses that have yet not joined the UDAY scheme are Telangana, Madhya Pradesh Maharashtra, Tamil Nadu and West Bengal. Ind-Ra's analysis shows that once they do, state finances of even Telangana, Madhya Pradesh and Tamil Nadu will come under stress.

Despite showing a marginally better fiscal performance, states at the aggregate level are likely to miss the fiscal deficit target of 2.8% of GDP in FY17 by a wide margin. Similarly, despite showing an improvement over FY16 (RE), the combined revenue account of the states will miss the budgetary target of FY17. However, the agency does not foresee any risk to the aggregate debt sustainability of the states in the medium term.

Only 12 out of 23 states will be able to take the advantage of the window for additional borrowings in FY17 provided by the 14th Finance Commission (14FC). Among these 12 states, two fulfilled the criterion of interest/revenue being below 10% in the preceding year, four fulfilled the criterion of debt/GSDP less than 25% in the preceding year and six states fulfilled both these criteria in the preceding year. Thus, the states that fulfilled only one criterion became eligible for an additional borrowing of 0.25% of GSDP and the states that fulfilled both criteria became eligible for an additional borrowing of 0.50% of GSDP over and above the annual limit of 3.0% of GSDP.

The aggregate capex of state governments (FY16: 10.64% of GDP) is nearly double the capex of central government (FY16: 5.41%). Ind-Ra, however, believes the capex of state and central government together can play only a limited role in reviving the capex cycle as an overwhelming proportion of the total capex (FY16: 83.96% of GSDP) in the economy comes from the private sector (including central and state public sector undertakings and households). Aggregate capital expenditure by states in FY16 grew 50.5% compared to 20.9% by the central government. In fact, growth in the aggregate capital expenditure of states has been consistently been higher than the central government's since 1990s and the actual aggregate capital expenditure of the states has been higher than the capital expenditure of the central government since FY06.

Ind-Ra believes the impact of pay revision of state government employees in line with the recommendations of the Seventh Central Pay Commission will be felt only in FY18. The Seventh Central Pay Commission award is under review by a committee, and its impact is likely to be less severe than the award of earlier pay commissions on state finances due to a lower arrear pay out. Ind-Ra's estimate shows that the likely impact of the recommendations of the Seventh Central Pay Commission on state government finances will be INR1.58trn in FY18 (0.95% of GDP).

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