States to borrow more, miss fiscal targets by 50 bps: Nomura

Implementation of 7th Pay Commission, interest payments on Uday bonds, over-budgeting of their share of tax transfers from the Centre and election-related spending are the reasons

A total of 16 large states are set to borrow more again this fiscal despite higher allocations from the Centre, with the cumulative borrowing likely to reach Rs 3.5 lakh crore from Rs 2.95 lakh crore in 2015-16, says a study.

According to the study by Japanese brokerage Nomura, which was based on the 2016-17 budgets of 16 states, this comes on top the sharp 22 per cent rise in borrowings in the previous fiscal despite an increase in central transfers.

"Taking four major risks into account, we expect the state fiscal deficit to rise to 3.3 per cent of GSDP in FY17 (ex-Uday loans), a notch higher than 3.2 per cent in FY16 (ex-Uday loans), but a slippage of 50 bps relative their FY17 budgets," Nomura India Chief Economist Sonal Varma said in a note.

The four risks, according to her, are implementation of the 7th Pay Commission, interest payments on Uday bonds, over-budgeting of their share of tax transfers from the Centre and election-related spending.

In the past financial year, these states borrowed 22 per cent more than budgeted, while in the previous fiscal year it jumped a whopping 70 per cent more than estimated.

Accordingly, she says, "states market borrowings to rise to Rs 3.5 trillion in FY17 from Rs 2.95 trillion in FY16. The redemption profile, Uday-related interest burden and the implementation of the seventh pay commission in most states by FY18 will push their borrowings higher to Rs 3.9 trillion in FY18."

The fiscal deficit of the 16 states rose to 3.2 per cent of GSDP (gross state domestic product) in 2015-16 (excluding the Uday loans), which is a slippage of 40 bps from budgeted levels, which rose due to shortfall in tax revenue.

According to Nomura, the assessment comes even as these states have budgeted for a fiscal improvement in 2016-17 to 2.8 per cent (excluding-Uday loans) from 3.2 per cent in 2015-16, as it sees four upside risks to state finances this fiscal.
"With both the Centre and states budgeting for

consolidation, the combined fiscal stance is largely neutral with a fiscal impulse of 0.2 bps in FY17, lower than the 0.7 bps in FY16. However, we expect the states to slip on the fiscal front, leading to a mildly expansionary fiscal stance in FY17," she said.

Varma also said this will push their borrowing costs higher with the state bond yield versus the 10-year G-sec yield spread to remain elevated at 50-70 bps.

One of the key surprises in 2015-16 was the sharp rise in state borrowings. Total market borrowings by the states rose 22 per cent y-o-y to Rs 2.95 trillion, after rising a sizeable 70 per cent in the previous fiscal.

State market borrowings accounted for just 12 per cent of general government gross market borrowing in FY17, but in FY16, it stood at 33 per cent.

The rise was particularly surprising for two reasons. First, in the spirit of cooperative federalism, the 14th Finance Commission had recommended an increase in states' share of Central taxes from 32 per cent to 42 per cent.

Higher tax allocations were partly offset by lowering grants to the states, but the Centre estimated that its net resource transfer to the states would rise from around 5.5 per cent of GDP in FY15 to around 6.2 per cent in FY16.

While these states had budgeted an aggregate fiscal deficit of 2.8 per cent in FY16, the actual figure is much higher at 3.9 per cent of their combined GSDP, primarily due to accounting idiosyncrasies as several states (Rajasthan, UP, Haryana) have included bond issuances under the Uday scheme as part of their capital expenditure, it said.

According to the Fiscal Responsibility and Budget Management (FRBM) Act, states are mandated to contain their fiscal deficit at 3 per cent of GSDP. Yet as many as 5 out of 16 states (Rajasthan, Telangana, Bihar, MP, UP) have breached this limit, even after discounting for Uday loans.