State governments’ fiscal rectitude, with the notable exceptions of West Bengal, Kerala and Punjab, stands in stark contrast to New Delhi’s profligacy, says BNP Paribas equities research report
Much attention has been focused on the inability of the government to manage its finances, especially New Delhi’s inability to curtail subsidies. But, as the famous adage goes, “whatever is true of India; the opposite is equally true”, says BNP Paribas in a recent research note. New Delhi’s inability to rationalize subsidies has rendered the fiscal responsibility legislation moot. However, state governments’ fiscal rectitude, with the notable exceptions of West Bengal, Kerala and Punjab, stands in stark contrast to New Delhi’s profligacy, finds BNP Paribas.
Indian states have wide-ranging responsibilities from education, healthcare, law & order, justice and agriculture. But their revenue sources are much more limited—major revenue sources for states are value-added taxes; taxes on alcohol; narcotics; entertainment and gambling; motor vehicle taxes and stamp duties. As a result, states are dependent on the central government for financial resources—more than 40% of the states’ revenue comes from central government transfers.
After a blip because of the global financial crisis and implementation of the Sixth Pay Commission recommendations (which increased civil servants’ pay), state finances have shown a stark improvement. They have managed to bring down their fiscal deficits from 2.9% of GDP (Gross Domestic Product) in FY10 to 2.5% of GDP in FY13 (budget estimate—BE) while a revenue deficit of 0.5% of GDP has been turned into a revenue surplus of 0.2% of GDP in FY13 BE. Most states have met the Thirteenth Finance Commission target of revenue deficit of 0% and of fiscal deficit of 3% of GSDP (Gross State Domestic Product) by FY12. The central government’s fiscal deficit of 5.8% of GDP for FY13 is far from the finance commission’s target of 4.2% of GDP.
Interestingly, almost all states, including the fiscally stressed states of Punjab, West Bengal, and Kerala, have forecast a fiscal deficit of less than 3% of GSDP in FY13. Each of these states has also budgeted for a sharp reduction in the revenue deficit for FY13. That sounds too good to be true, but it is true, according to BNP Paribas.
The other major concern is the strain of state electricity board (SEB) losses on state budgets. Media reports suggest that as part of their financial restructuring, respective state governments may have to assume part of the SEB debt. Can SEB losses upset the apple cart? No, according to BNP Paribas.
Media reports suggest that a Planning Commission panel has proposed that state governments absorb half the debt of the SEBs and convert it into state government bonds. Will this derail the process of fiscal consolidation of the states? Barring Jammu & Kashmir, states’ deficit and debt dynamics remain manageable even after assuming half of the accumulated losses of the SEBs. The states which have the biggest accumulated SEB losses—Rajasthan, Tamil Nadu, Uttar Pradesh and Madhya Pradesh—will comfortably maintain fiscal deficit at about 3% of GSDP (FY13E) even including the servicing cost of SEB debt. Even their debt-GSDP ratio, with the exception of Rajasthan and Jammu & Kashmir, will not increase materially. While the concern of quality of loans to private developers remains, it is believed that investor concerns over SEB loans may be misplaced, according to BNP Paribas.