State of Concern Due to Increased Market Borrowings By the States : Daily Current Affairs

Relevance: GS-3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment; Government Budgeting;

Key Phrases: Unsustainable borrowing; Fiscal consolidation; to meet the additional pandemic-related expenditure; to service rising interest costs; Fiscal Responsibility and Budget Management (FRBM) Act - debt to GSDP ratio for States at 25%; and to reach 20% by 2023;

Context

The fight against the COVID-19 pandemic has put serious pressure on the government purse.
Fighting once in a century crisis needed expenditure on several fronts (health security, income support, social safety nets, etc). This has caused the governments to go back on the promise of fiscal consolidation.

Key Highlights

Increased market borrowings by the States

An analysis of the debt of the top 15 States in terms of GSDP has shown that most States in FY21 and FY22, have increased market borrowings to meet the additional pandemic-related expenditure. This is after revenue receipts took a hit in the first year of the pandemic.
The interest cost for 7 of the top 15 States has increased more than 40% between FY19 and FY22.
- With revenue not keeping pace, the capacity of States to service rising interest costs is declining sharply, as indicated by reducing interest cover.
Along with interest costs, many States will witness an increase in other committed expenditures such as salaries and pensions too, with the result that committed expenditure of States as a proportion of revenue receipts is budgeted to increase to 56% in FY23.

Do you know?

Revenue expenditure refers to the expenditure that neither creates an asset nor reduces the liability of the government. They are regular and recurring; Short-term; Example-Payment of salaries, maintenance of roads, street lights, etc.
Capital expenditure refers to the expenditure that either creates an asset or reduces the liability of the government. They are irregular and non-recurring; Long-term; Example- Construction of metros, dams etc., repayment of loans to IMF etc., purchase of machinery, etc.
Monetary policy is concerned with the management of interest rates and the total supply of money in circulation. It is generally carried out by the RBI.
Fiscal policy estimates taxation and government spending. It should ideally be in line with the monetary policy, but since it is created by lawmakers, people's interest often takes precedence over growth.
Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003. The objective of the Act is
- to ensure inter-generational equity in fiscal management;
- long-run macroeconomic stability;
- better coordination between fiscal and monetary policy and
- transparency in the fiscal operations of the Government.
It became effective from July 5, 2004.
The FRBM Act of the Centre was amended in 2018 to set a ceiling on general government debt at 60% of GDP by 2024-25 (with 40% limit on the Centre’s debt).

Neglect of FRBM Act

The Fiscal Responsibility and Budget Management (FRBM) Act lays down the ceiling for debt to GSDP ratio for States at 25%.
- Whereas, 8 of the 15 States exceeded the limit in FY22 with States such as Punjab, Rajasthan and Bihar far above the mandated level.
FRBM committee had recommended that the combined debt of States should reduce to 20% of GDP by 2023,
- Whereas, State debt is set to exceed 33.5 % of GDP by the end of FY23 (as per SBI Research).

Issues with developmental expenditure

There is little room for developmental expenditure that can help in the long-term growth of the State.
Many of the larger States including Maharashtra, Tamil Nadu and Karnataka have recorded a decrease in capital expenditure in the revised estimate for FY22 when compared with the budget estimate.
- With the States having to bear a large part of the capital expenditure burden, this reduction in capital investment could have ramifications on overall growth in the economy.

Way Forward

States must be nudged back to the path of fiscal prudence soon, or else their borrowings can spin out of control, with repercussions on growth.
States must rationalise their borrowings, which is leading to a high-interest burden, crowding out other productive expenditures.
- Unsustainably high debt levels can lead the states towards a debt trap, where most of the revenue is used up to service the debt.
Rationalise expenditure
- They need to introspect on the efficacy of freebies and subsidies which drain the exchequer without contributing to development.
- Some of the heavily debt-laden States such as Punjab, Rajasthan and Bihar also top the list of States with a high proportion of average subsidy as per cent of GSDP.
- The governments in many of these States are continuing to announce populist schemes, unmindful of their finances.
The FRBM committee must set out a glide path for States to bring their deficits and borrowings back to prudent levels, as soon as possible.
- As the economy begins a gradual recovery from the pandemic, States must look at ways to improve their finances by directing expenditure toward more productive areas.
  - Capital Expenditure must be one such area.
With tax revenue showing buoyancy in recent months, due to a revival in economic activity, States can repair their finances if they are careful with their expenditure.