The curse of debt

States must not stray from fiscal discipline

West Bengal Finance Minister Amit Mitra has highlighted an issue of critical importance - the rise in the indebtedness of his state, and indeed of many other states. In an interview with this newspaper, he has also urged the Centre to examine ways to mitigate the debt-induced stress that states like his are faced with. Mr Mitra is right in his diagnosis that the problems arising out of worsening state indebtedness will not only impair the fiscal health of the states concerned, but also be harmful for India's growth prospects. The Centre, therefore, cannot wash its hands of the responsibility of assessing what is ailing states' finances and what needs to be done to repair the damage. In the last four years, the aggregate liabilities of state governments have seen a double-digit growth every year, ranging between 10.8 per cent and 12.7 per cent. The share of states' consolidated debt in gross domestic product (or GDP), however, has stayed at around 22 per cent, below the target of 24.3 per cent recommended by the Thirteenth Finance Commission. This is also lower than the 25 per cent cap identified by the Fourteenth Finance Commission as a condition states must fulfil if they were to exceed their fiscal deficit target of three per cent of gross state domestic product (or GSDP) by 25 basis points.

But this may be cold comfort. While in the aggregate, states are within the overall target of consolidated debt, the annual trend is a cause for concern, as many of them are showing year-on-year higher debt levels even as per cent of GSDP. In particular, West Bengal and Jammu & Kashmir have even exceeded the target of debt set by the Thirteenth Finance Commission. Equally disturbing is the steady rise in market borrowings by states in recent years that could be caused among other things by a decline in both the net collections under the National Small Savings Fund and the flow of loans from the Centre. This has significantly pushed up states' repayment obligations from 2017-18 onwards.

What seems to be a bigger cause for concern is that states' outstanding liabilities are set to rise in the coming years on account of the phased takeover of bonds issued by state-owned power distribution companies under the recently launched financial restructuring plan for the power sector. Financially stressed banks may be relieved, but their burden is now set to bloat the debt levels of states. An additional burden is likely to be caused when many state governments will be obliged to increase the pay packages for their employees, in line with the recommendations of the Seventh Central Pay Commission, which will be implemented by the Centre from this month. The combined impact of rising outstanding liabilities, higher market borrowings, and the additional burden arising out of the power sector bonds and pay commission awards will further strain states' fiscal health, leading to slippages in meeting the stipulated fiscal deficit targets for many of them. This will be an unfortunate outcome with serious implications for the states and the economy in general. While accepting the demand for restructuring debts could help in the short run, there is a need for more sustainable measures to stem the rot that has set in. Adherence to fiscal prudence and ensuring that states meet the stipulated deficit targets can go a long way in reducing their debt burden in the medium to long term.