Higher expenditure on salaries and farm loan waivers, coupled with a revenue shortfall on GST implementation, led to a slippage of 0.35 per cent in states' fiscal targets to 3.1 per cent in 2017-18, the RBI said today.
This is the third consecutive year where the states have failed to meet their gross fiscal deficit (GFD) target, the central bank said, adding this comes despite expectations of an improvement on higher devolution from the Centre.
For FY19, states are hoping for a 0.2 per cent revenue surplus as against a revenue deficit of 0.4 per cent as per the revised estimates, which will lead to an overall GFD of 2.6 per cent, against 3.1 per cent in FY18, it said.
At a country-wide level, farm loan waivers alone contributed to a third of the overall slippage worries, with a 0.05 per cent slippage of the overall 0.13 per cent on revenue expenditure, the RBI said in its study on state finances based on state budgets.
The apex bank reiterated its concerns on the "moral hazard" farm loan waivers, saying their track record for improving productivity is "unproven".
Moreover, studies suggest that the debt waivers have also led to a shift to informal sources of finance, it said, adding that they also possess a risk to inflation.
Starting with Andhra Pradesh and Telangana in 2014, a slew of states including Tamil Nadu, Maharashtra, Uttar Pradesh, Punjab and now Karnataka have announced the sops.
In FY18, farm loan waivers touched 0.32 per cent of the GDP as against budget estimates of 0.27 per cent, it said, adding that more such moves are pending for the fiscals ahead.
States which have announced the waivers have also reported a decline in capital expenditure, it said, adding development has also been a casualty because of it.
"They (waivers) impact credit discipline, vitiate credit culture and dis-incentivise borrowers to repay loans, thus engendering moral hazard," the study said.
Hikes in salaries, mainly as a higher proportion of states implement proposals in line with the seventh pay panel, resulted in 0.09 per cent slippage on the revenue expenditure.
"The decline in states' tax revenues is essentially associated with the pending accounting issues related to GST implementation," it said.
However, in his foreword, RBI's executive director Michael Patra said that as the GST stabilises, it should boost states' revenue capacity and support fiscal consolidation.
He, however, asked states to be more cognizant on the expenditure management in the future as "visible fiscal pressures" are emerging for several states on pay revisions, interest payments and farm loan waivers.
"Given debt sustainability concerns associated with rising market borrowings, improved efficiency of expenditures and fiscal marksmanship may be necessary to sustain growth while maintaining fiscal prudence," he said.