Indian States’ Rising Debt Pose Risk to Their Finances, RBI Says

Indian states are racking up more debt to fund the prospect of wider budget deficits as they step up spending to fight the virus pandemic, the central bank said.

“States have been at the forefront in the fight against the pandemic and the public health crisis it has spawned, besides the biggest migration in the world,” the Reserve Bank of India said in a report — Study of State Finances —published Tuesday. “The debilitating combination of compression in tax receipts and ramped-up expenditures has generated unprecedented pressures on fiscal positions at sub-national levels.”

India’s federal government revised its borrowing plan for a second time to a record 13 trillion rupees ($177 billion), with the additional 1.1 trillion rupees penciled in to compensate states for the shortfall in goods and services tax collection. The pandemic has ravaged revenues of both the federal and state governments and pushed the economy toward the worst contraction on record, with the central bank seeing gross domestic product declining by close to 10% in the quarter ended September.

Based on the study of states’ budget for the year to March 2021, India’s provinces have budgeted a combined gross fiscal deficit of 2.8% of gross domestic product. While that is lower than the 3.2% seen in the year to March 2020 and the 3% cap set by the law, the RBI sees the estimates being breached substantially given the fallout of the pandemic.

Undermine Targets

The virus is “likely to undermine fiscal targets and associated receipts for 2020-21,” the central bank said. “The consequent rising levels of debt and guarantees pose risks to state finances, going forward.”

The maturity profile of states’ debt suggest that redemption pressure is likely to double from 2026 onwards. It implies borrowings by provinces might soar in the coming years and could lead to crowding out of the private sector in a market already cramped by issuances by the federal government and state-run enterprises.

Economists estimate the combined fiscal gap of states and the federal government will blow out to double digits. A Bloomberg survey of economists shows the federal government’s budget gap will probably widen to 8% of GDP, compared with the government’s target of 3.5%.

Earlier this year, the RBI increased the ways and means advance facility for states to overcome the crisis they faced due to the virus. It also made relaxations on their overdraft facilities, both of which wereextended until the end of the financial year on March 31.

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