Indian states' borrowings from the market increased by 5.34% in FY23 with Tamil Nadu borrowing the maximum ₹65,722 crore among all states. Tamil Nadu is at the top for the last 3 years, says the latest data released by Reserve Bank of India (RBI).

In FY23, all states put together borrowed ₹5.19 lakh crore against ₹4.92 lakh crore in FY22. Tamil Nadu’s borrowings have declined from ₹72,500 crore to ₹65,722 crore.

"Though the GST and other tax revenue have been increasing it is yet to be as buoyant as seen before the pandemic. But on the other side, the expenditure is on the rise as the state government had to support the poor during the pandemic by announcing cash support and free rice," says a senior finance department official.

Tamil Nadu's rate of borrowing is also likely to be higher in the present year as the budget presented a few months back says ₹82,626 crore is expected to be the amount borrowed.

"Tamil Nadu is a state where several sections of the population are getting something or the other free of cost. Take middle class, electricity is free for the first 100 units, farmers get free power and so also weavers and other class of society," said Madras School of Economics director K R Shanmugam.

He says though the state’s tax revenue has increased and has crossed the budget target still there is no buoyancy to be seen. "Unless there is buoyancy in the tax revenue, the market borrowings will not decline as the previous government as well as present government has announced new welfare measures. From September 15, women head of households are to get 1000 per month and the budget has sanctioned ₹7,000 crore towards the same," said Shanmugam.

Other states have also borrowed more than last year. "Prior to the pandemic, the average Gross Fiscal Deficit to Gross Domestic Product (GFD-GDP) ratio of the states was 2.5% between 2011-12 and 2019-20, lower than the Fiscal Responsibility Legislation (FRL) ceiling of 3%. However, there were states like Andhra Pradesh, Kerala, Punjab, and Rajasthan incurring average GFD of above 3.5% of GSDP (gross state domestic product)," said Shanmugam who has done a study on various states’ financial health.

The pandemic led to a sharp decline in revenue, an increase in spending, and a rise in debt to GSDP ratios, resulting in a deterioration of the fiscal positions of the states. Based on the debt-GSDP ratio in 2020-21, Punjab, Rajasthan, Kerala, West Bengal, Bihar, Andhra Pradesh, Jharkhand, Madhya Pradesh, Uttar Pradesh, and Haryana were identified as the states with the highest debt burden. These ten states accounted for around half of the total expenditure by all state governments in India, Shanmugam said.

Bihar, Kerala, Punjab, Rajasthan, and West Bengal were identified as highly stressed states. The GFD-GSDP ratios of these states were equal to or more than 3% in 2021-22, besides deficits in their revenue accounts (except Uttar Pradesh and Jharkhand). Moreover, the interest payment to revenue receipts (IP-RR) ratio, a measure of debt servicing burden on states’ revenues, was more than 10% in eight of these states.

Among the ten identified states, Andhra Pradesh, Bihar, Rajasthan, and Punjab exceeded both debt and fiscal deficit targets for 2020-21 set by the 15th Finance Commission. The Commission has permitted states to maintain the ratio of Fiscal Deficit to GSDP as 3.0% in 2023-24 and 2024-25, with an additional space of 0.5% of GSDP during 2021-22 to 2024-25 on fulfilment of required power sector reforms.

In the current financial year too market borrowings are set to fund 75% of fiscal deficit of states, according to a report by rating agency ICRA. This would imply net issuances of ₹6.7 lakh crore ($89.7 billion) in bonds by states to finance the gap between their total revenue and expenditure.

According to ICRA, finances remained within the prescribed limit for most states in the last six years with the base borrowing limit of state governments varying from 3-4% of Gross State Domestic Product (GSDP) during FY18-24. During the period, additional borrowing of 0.5-1% of GSDP was also provided to states based on outcome related to prescribed targets and reforms.

The borrowing limit acts as a soft constraint on the size of the fiscal deficit that states can incur. It is normally provided by the Centre. The agency in its research report also said that market borrowings made up a peak of 96% of funding for the states’ deficit in FY20.

But this number has been declining since then, reaching 84% in FY21 and falling below 80% in FY22 and FY23. This decline was partly offset by an increase in loans from the central government, ICRA said.

The agency expects that the trend of falling market borrowings would continue in FY24, with only 75% of the fiscal deficit being funded by net market borrowings, although Budget estimates (BE) indicate that the share of market borrowings will be 79%.

ICRA said that higher loans by the Centre to states were primarily made up of Goods and Services Tax (GST) compensation loans in FY21 and FY22. However, in FY23 RE and FY24 BE, interest-free capex loans from the Government of India (GoI) are expected to fund over 10% of the states’ fiscal deficit.

The agency also said that despite several states breaching their borrowing targets, on an aggregate basis, the fiscal deficit of the sample states remained within the limit in recent years. This was due to revisions in GSDP and higher borrowing through funds in the public account, which funded 2-20% of the fiscal deficit of states during FY18-FY23 RE.

However, the public account is a volatile source of funding, as there is no prescribed legislative approval for withdrawing money from it. Therefore, it may continue to be used to fund the fiscal deficit of state governments in the near to medium term, said the report.

Overall, the report suggests that Indian states will continue to rely heavily on market borrowings to fund their fiscal deficits, with loans from the central government playing a smaller role in coming years.

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