After a period of consolidation, Indian states’ debt levels are on the rise again and could pose a challenge in the medium term, the Reserve Bank of India warned in its annual public finance survey. In addition to factors such as lower growth due to spending cuts, which could impact public debt sustainability, risks arising from Ujwal DISCOM Assurance Yojana (UDAY) continue to hang over states, warned the central bank.
The debt-to-GDP ratio in all the states and territories of the Union is estimated at 24.9% for fiscal year 20, close to the levels observed in recent years. However, state-to-state performance varies widely, and at least 20 states have passed the threshold for a 25 percent debt-to-GDP ratio, according to the report released on Monday.
Total Indian states debt is expected to rise to Rs 52.58 lakh crore in FY20, an increase of 11.5% over last year. The expected increase in debt is greater than the 9.8% increase observed in FY19.
India has the highest subnational debt compared to other BRICS countries, the RBI said. “The state government debt position started showing emerging signs of unsustainability, especially after UDAY,” he added.
Under the UDAY program, implemented in 2015, state governments assumed 75% of the unpaid debts of electricity distribution companies in the form of grants or equity. The program also led to an increase in the ratio of interest payments to state revenues, the RBI said.
Variance between states: the best and the worst performers
Data included in the RBI report shows that debt performance in major states varies widely. Despite repeated attempts, investors in state government securities do not differentiate much between states based on their individual performance.
Without an incentive for prudence or better performance, a number of large states now have higher debt-to-GDP ratios.
Among the large states, Punjab has the worst debt-to-GDP ratio of 39.9%, followed by Uttar Pradesh, where debt levels have reached 38.1% of GDP. Himachal Pradesh, Rajasthan and West Bengal also have debt-to-GDP ratios well above the threshold.
In contrast, Assam, Gujarat, Karnataka, Maharashtra, and Telangana have the lowest debt-to-GDP ratios among the major states.
In addition to the debt-to-GDP ratio of states, the RBI also reported the increase in guarantees given by the state. Data obtained from the Comptroller and Auditor General and the State Finance Departments show that the amount of guarantees granted increased sharply from 37.7% in 2017-2018 to 2.5% of GDP.
“In terms of sectoral exposure distribution, the electricity sector remains dominant – representing on average more than 60% of total outstanding guarantees. For a few states, it was over 80% – followed by the transportation sector, ”the RBI said.
The lingering impact of the UDAY 2015 program continues to be felt on state finances and could even worsen over the next two years if the performance of distribution companies does not improve, the RBI has warned.
The regime continues to impact the state’s finances in several ways.
First, the states that were part of the program experienced an increase in interest payments as coupon rates on UDAY securities were higher than state government bonds.
Second, states had signed an agreement to bear a greater share of DISCOM losses each year. According to the agreement, states would assume:
- 10 percent of DISCOM losses from the previous year in 2018-19
- 25 percent of DISCOM losses from the previous year in 2019-20
- 50 percent of DISCOM losses from the previous year in 2020-2021
As such, the health of DISCOM will remain critical to the state’s debt for years to come, the RBI said.
“Another potential impact of UDAY could materialize through the assumption of additional losses of DISCOM, as provided for in the UDAY agreements, especially since the benefit of subsidies to supplement income will not be available for some states” , said the RBI.
Budget deficit in check but at a cost
As medium-term concerns about debt sustainability reappeared, governments have managed to bring budget deficits under control, often by cutting spending.
The gross budget deficit ratio among states is estimated at 2.6 percent for FY20, compared to the revised estimate of 2.9 percent for FY19.