States need to take credible steps to address debt sustainability concerns: RBI report

As the impact of the second wave of the Covid pandemic wanes, the State governments need to take credible steps to address debt sustainability concerns, according to a Reserve Bank of India (RBI) report.

The report “State Finance: Study of Budgets” noted that the combined debt-to-GDP ratio of States, which stood at 31 per cent at end-March 2021, is expected to remain at that level by end-March 2022 and is worryingly higher than the target of 20 per cent to be achieved by 2022-23, as per the recommendations of the Fiscal Responsibility and Budget Management (FRBM) Review Committee, chaired by NK Singh.

In view of the pandemic-induced slowdown, the 15th Finance Commission expects the debt-GDP ratio to peak at 33.3 per cent in 2022-23 (given the higher deficits in 2020-21, 2021-22 and 2022-23), and gradually decline thereafter to reach 32.5 per cent by 2025-26.

The report observed that the budgeted gross fiscal deficit (GFD) of 3.7 per cent of GDP for States for the year 2021-22 – lower than the 4 per cent level as recommended by the 15th FC – reflects the State governments’ intent towards fiscal consolidation.

The report said in 2021-22 so far (April-September 2021), the gross and net market borrowings by State governments have been 13 per cent and 21 per cent lower than in the corresponding period of the previous year, respectively.

States have preferred to borrow from the financial accommodation provided by the RBI through short-term borrowing via the special drawing facility (SDF) and ways and means advances (WMA).

Additionally, in recent years, the States have been accumulating sizeable cash surpluses in the intermediate treasury bills (ITBs) and auction treasury bills (ATBs), although they involve a negative carry of interest rates for the States. The report underscored that this warrants improvements in cash management practices.

Power sector reforms

The report emphasised that in the medium term, improvements in the fiscal position of State governments will be contingent upon reforms in the power sector as recommended by the 15th FC and specified by the Centre – creating transparent and hassle-free provision of power subsidy to farmers, preventing leakages, and improving the health of the power distribution companies (DISCOMs) by sustainably alleviating their liquidity stress.

The report opined that timely payments of State dues to DISCOMS and, in turn, by them to generation companies (GENCOS) hold the key to the sector’s financial health.

As per the assessment of the RBI’s Department of Economic and Policy Research, undertaking power sector reforms will not only facilitate additional borrowings of 0.25 per cent of GSDP by the States but also reduce their contingent liabilities due to the improvement in the financial health of the DISCOMs.

Third-tier front

On the third-tier (urban local bodies) front, the report recommended increasing the functional autonomy of civic bodies, strengthening their governance structure and financially empowering them via higher resource availability through self-resource generation and transfers, as they are critical for building resilience and effective interventions at the grass-root level.

The State governments should set up State Finance Commissions (SFC) at regular intervals, in line with the recommendations of the 15th FC. The report said States may also urge rural and urban local bodies to make audited accounts available online in a timely manner to access grants.

In addition, States should undertake local body reforms as stipulated by the Centre to improve the financial autonomy of third-tier governments. “Overall, the sub-national fiscal positions are at an inflection point.Empowerment of the third-tier government presents an opportunity that can result in better and more effective pandemic crusaders in the future,” the report said.