Here’s what the fiscal health of Indian states looks like post-demonetisation and GST

It seems that India’s slowing GDP growth in 2017-18, in the wake of demonetisation, an overhaul of the tax regime and a decline in manufacturing and investment, has had an adverse impact on the financial strength of its states. According to a report by CARE Ratings, a credit ratings agency, 14 out of 24 states recorded a decline in their net financial position, as per latest estimates, in the year ended March 2018.

Of the 14 states that recorded a revenue surplus, which occurs when revenue receipts are higher than revenue expenditure, eight saw a lower surplus than the year before, including Uttar Pradesh (₹185.2 billion), Bihar (₹14.5 billion) and Odisha (₹88.7 billion). However, a revenue surplus isn’t an obvious indicator of financial strength. Many states which record surpluses like Uttar Pradesh, which has the highest surplus, spend less than their budget estimates on agriculture and education, resulting in lower expenditure.

Meanwhile, 10 states recorded a revenue deficit, out of which 6 experienced a higher deficit than the previous year. These include Rajasthan (₹201.7 billion), Tamil Nadu (₹183.7 billion) and Maharashtra (₹148.4 billion). Assam recorded the highest deficit at ₹233.5 billion, compared to a mere deficit of ₹1.4 billion the previous year, as it significantly overshot its budgeted expenditure on agriculture, police resources, education and health.

Spending beyond their means

Another cause for concern is that more states are spending beyond their means. The number of states with a fiscal deficit, the difference between total revenue (excluding borrowings) and total expenditure, that is larger than 3% of GDSP (a state’s gross domestic product) has increased from 10 in 2016-17 to 14 in 2017-18.

The 14th Finance Commission recommends a maximum limit of 3% on state fiscal deficits. In fact, 5 states actually had a deficit ratio higher than 3.5%. Bihar stood out as the state with the worst ratio, at 7.5%, partly owing to higher spending on pensions, education and rural development.

India’s states are increasing the amount they spend on asset creation, in lieu of future growth and development. Around 14 out of 24 states reported a higher capital outlay, or the money spent on infrastructure creation and fixed assets, as a percentage of total expenditure. Goa had the highest allocation, at 27% of total expenditure, followed by Jammu & Kashmir and Bihar.

It bears mentioning that Uttar Pradesh, Maharashtra and Punjab all extended generous loan waivers last year. However, as shown below, it seems that only Maharashtra can afford the waivers.

Maharashtra and Uttar Pradesh have the highest debt levels

Maharashtra, India’s richest state, had the highest level of outstanding debt with ₹4.07 trillion, closely followed by Uttar Pradesh, one of India’s poorest states, with a debt burden of ₹4.06 trillion. This is roughly equivalent to the cost of 306,000 Lamborghini Gallardos.

However, given its high GDSP, Maharashtra has a debt-to-GDSP ratio of only 16.3%, well below the Finance Commission’s maximum permissible limit of 25%, while Uttar Pradesh has a debt ratio of 29.5%.

The reports show that 8 out of 19 states had a debt-to-GDSP ratio over 25%. Punjab and Jammu & Kashmir had worryingly high debt ratios, at 41% and 46.4% respectively. Along with West Bengal and Haryana, Punjab spends more than 20% of its revenue receipts on interest payments alone, which results in lower development spending.

Only four states - Karnataka, Telangana, Odisha and Chattisgarh - proved to be efficient at managing their debt obligations. In addition to having a debt-to-GDSP ratio of less than 25%, these states also allocated less than 10% of their revenue receipts to interest payments.

An improvement in 2019?

In light of their declining financial strength, India’s states will focus on fiscal consolidation and cost control in the current fiscal year. Only 7 states are budgeted to have a revenue deficit in 2018-19, out of which 4 expect to reduce their revenue deficit. West Bengal, Assam and Andhra Pradesh, all of which recorded a revenue deficit last year, expect to record a surplus or a neutral balance in 2018-19. Meanwhile, all the 14 states that recorded a revenue surplus last year, expect to do so in 2018-19 as well, with 9, including Gujarat, Uttar Pradesh, Chhattisgarh and Bihar, planning to increase their surplus.

These states will continue to count on the generosity of the central government for grants-in-aid and tax revenues. According to PRS Legislative Research, a think tank, states derive 46% of their revenue from the central government’s coffers. Grants account for 20% of state funding while the states’ share of central taxes account for 26%. Given their dependence on the central government, it isn’t hard to see why so many voters in state elections favour the party that is in power at the centre.