The Fourteenth Finance Commission (FFC) prescribed certain fiscal rules for the State Governments, including an annual fiscal deficit threshold limit (and borrowing limit net of repayments) of 3.0% of GSDP for the period 2015-16 to 2019-20. ICRA has analysed the emerging fiscal trends for nine General Category States. Seven of these nine States except Kerala and Haryana, expect their fiscal deficit in 2015-16 (as per Budget Estimates or BE) to be in line with the anchor of 3.0% of GSDP set by the FFC. However, in the absence of explicit incentives being provided by the FFC, a majority of the State Governments in the sample have indicated continued revenue account deficits in 2015-16 BE, despite the enhanced devolution of Central taxes from the Government of India (GoI).
While urban consumer demand remains relatively healthy benefitting from the moderation in inflation, rural sentiments have been weakened by the sub-par monsoon rainfall as well as the unfavourable start to the rabi season, which is expected to have dampened States’ sales tax revenues to an extent in the current year. Moreover, the decline in retail prices of petrol, diesel and ATF is likely to impact the aggregate growth of States’ sales tax revenues in FY16, with VAT on POL products accounting for over a quarter of the total forecasted sales tax/VAT revenues of the States in the sample in 2014-15 BE, although the impact of the same would be partly mitigated by healthy growth in consumption of such fuels. Overall, ICRA expects the pace of expansion of States’ sales tax collections to be moderate in 2015-16, as compared to the combined growth of 11.9% budgeted by the States in the sample.
“With the pace of growth of the GoI’s gross tax revenues in April-November 2015 exceeding the budgeted target, ICRA does not expect a meaningful shortfall in Central tax devolution to the States relative to the level budgeted by the GoI for 2015-16, in contrast to the trend recorded in the previous four years”, said Jayanta Roy, Senior Vice President and Head Public Finance Ratings, ICRA. However, the actual transfer from the Union to the State Governments for plan grants for Centrally Sponsored Schemes (CSS) schemes would be influenced by the decisions taken by the GoI post the recommendations of the Chief Ministers’ Sub-Group of NITI Aayog on CSS schemes, and may therefore differ materially from the amounts that were budgeted by the States for 2015-16. The nine States in the sample have budgeted for a modest increase in Central transfers of Rs. 238.3 billion in 2015-16 BE relative to 2014-15 RE. The manner in which they choose to spend the additional untied funds remains to be seen.
Post the mixed success of the Financial Restructuring Scheme (FRP) scheme for State-owned Electricity Distribution Corporations (Discoms), the GoI approved a scheme called Ujjwal Discom Assurance Yojana (UDAY) on November 5, 2015 with an objective of financial turnaround of the Discoms. This scheme, which is optional for States, envisions takeover of 75% of Discom debt and a portion of the losses of the Discoms by the respective State Governments, but does not provide explicit cash incentives for the same. So far, 15 States including Rajasthan, Punjab, Haryana, Maharashtra and Gujarat have confirmed participation in the UDAY scheme. The interest servicing of the debt being taken over from 2015-16 onwards (by issuing non-SLR SDL in the market or directly to the existing Lenders holding the Discom debt to the appropriate extent), as well as the losses of the Discoms that would be taken over by the States in the future, would enlarge the fiscal deficits of the participating States and bloat their borrowings going forward. For instance, assuming that the fresh non-SLR SDL equivalent to 50% of the debt of the Discoms, that is to be taken over in 2015-16, is issued at a coupon of 8.5% by the respective State Government, the interest burden of the States such as Gujarat, Haryana, Punjab, Rajasthan and TN (whose Discoms are estimated to account for over half of the total Discom debt of Rs. 4.3 trillion outstanding at end 2014-15) could go up by ~Rs. 2.0-35.0 billion per year, which would bloat their fiscal deficits by upto 0.5% of GSDP. The exact timing of takeover of the debt would determine the extent by which the interest burden increases from 2015-16 onwards. “With less than three months remaining in 2015-16, it is likely that the fiscal impact of the State Governments having to service the interest on their Discoms’ debt would be limited in the current year, but would ramp up considerably from 2016-17 onwards. As a result, some State Governments may need to reorient their spending or mobilize additional resources from next year onwards,” said Jayanta Roy, Senior Vice President and Head Public Finance Ratings, ICRA.
While a majority of the States in the sample have indicated compliance in 2015-16 with the fiscal deficit target set by the FFC, revision in pay and pension scales by several State Governments, based on either the recommendations of the Seventh Central Pay Commission (SCPC) or those of their own respective Pay Commissions, would emerge as a fiscal challenge going forward. The magnitude and timing of pay revision at the State level and the extent of fiscal discipline displayed by the State Governments remain unclear at present. The availability of substantial liquidity through Treasury-bill holdings (T-bills; Rs. 1.4 trillion as on January 8, 2015, equivalent to nearly 30% of total T-bills outstanding of the GoI) would enable States to circumvent the FFC-set constraint imposed by the cap on annual net borrowings of 3.0% of GSDP on their fiscal deficits. In ICRA’s view, some States are likely to draw down their T-bill holdings in order to fund the fiscal impact of participation in the UDAY Scheme as well as the pay revision that they undertake going forward, rather than necessarily maintaining their fiscal deficit below 3.0% of GSDP.
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