Only Few States To Benefit From Provisions Of Fiscal Deficit Flexibility

The government recently has announced that states would be able to borrow beyond the 3% fiscal deficit ratio subject to three conditions relating to revenue surplus, ratio of interest payments to receipts and debt to GSDP. CARE Ratings has done a simulation to see which states would qualify for this additional leeway that has been afforded based on recommendations of the 14th FC.  The analysis shows that for a select set of 19 states, Madhya Pradesh, Karnataka, Odisha and Telengana could go up to 3.5% while Gujarat can go up to 3.25%. Interestingly some of them operate below 3% in which case the FC allows this saving to be used in the next year.

 

With the objective of outlining an approach towards fiscal consolidation and hence drawing up the fiscal roadmap, the 14th Finance Commission set out certain fiscal rules for the states for ensuring fiscal stability and discouraging over-borrowing. The Report stressed that there has been excessive focus on containing fiscal deficit and adherence to the fiscal limits prescribed by earlier Finance Commissions.

This resulted in constraining the capital expenditure of the states, adversely affecting their development spending. Therefore, it was of essence to provide headroom for the fiscally prudent states by way of developing fiscal consolidation plans whereby the states could take fresh borrowings in order to finance developmental expenditure. Hence, the 14th Finance commission recommended flexibility provisions in the fiscal deficit target for the states.

In April 2016, the Cabinet has given its approval to the 14th Finance commission’s recommendation on the fiscal deficit targets and additional fiscal deficit to be allowed to states. 14th Finance Commission has anchored the fiscal deficit threshold limit of 3% of GSDP for the states. Over and above this, it has provided additional headroom to a maximum of 0.5% of GSDP in a year. Nevertheless, availing of such flexibility is subject to certain conditions;

Revenue Position: The primary condition to avail any of these fiscal flexibility provisions is to have a comfortable revenue position. States can avail the additional fiscal deficit if and only if it does not have revenue deficit for the year in which the borrowing limits are to be fixed and the immediately preceding year.
If the states meet the above criterion the next set of conditions are, Debt to GSDP ratio: For a particular year at which the borrowing limits are to be fixed, the states will be eligible for flexibility of 0.25% over and above the fiscal deficit limit of 3% of GSDP if and only if their debt-GSDP ratio is less than or equal to 25% in the previous year.
Interest Payments to Revenue Receipts Ratio: Furthermore, the states will be eligible for additional borrowing limit of 0.25% of GSDP in a particular year for which the borrowing limits are to be fixed, if the ratio of interest payments to revenue receipts of the states is less than or equal to 10% in the preceding year.
The states can avail either of the two flexibility provisions or both depending upon the criteria they fulfil. If a state satisfies only one of the two criteria then it can have a maximum fiscal deficit limit of 3.25% of GSDP. On the other hand, if any state conforms to both the criteria then it can have a maximum fiscal deficit –GSDP limit of 3.5% in any given year.

In addition, if a state is unable to utilize its sanctioned borrowing limit of 3% of GSDP in any particular year during the first four years of the award period, it is then have an option of availing this un-utilized borrowing amount only in the following year but within the award period (2016-17 to 2019-20).

 

Illustration

To illustrate, in order to avail the benefit of additional borrowing for the year 2016-17,

 

The states should have revenue surplus for 2014-15 (accounts) and 2015-16 (revised estimates)

 

The debt/GSDP ratio should be less than or equal to 25% in the year 2014-15 (accounts)

 

The interest payment/revenue receipt ratio should be less than or equal to 10% in the year 2014-15 (accounts).

 

Through the flexibility in fiscal deficit the states are expected to get additional space for borrowings which can be utilized for government expenditure for capital projects and infrastructure.

 Simulation Analysis

Since the Cabinet has accepted the recommendation, it is imperative to understand the actual scenario with regard to compliance of criterion by the states and which states would benefit from this additional headroom. For analyzing the position of the states as per set norms, a sample of 19 states has been chosen. As per the condition for qualification for the flexibility of fiscal rules, the revenue positions of the states for last two fiscal years are pertinent.

 

Table 1 above shows the revenue positions of the selected states. Only five states namely,

– Gujarat,

– Karnataka,

– Madhya Pradesh,

– Odisha and

– Telangana

indicated revenue surplus for both years while other states disqualify as per prescribed norms. Therefore, only these five states are entitled for the additional borrowing limits over and above the fiscal deficit target of 3% of GSDP provided they comply with other two conditions for fiscal flexibility.

Table 1 CARE

Exhibit 1 and exhibit 2 below show the interest payment to revenue receipts ratio and debt-GSDP ratio of the selected states respectively. Since only five states have fulfilled the condition of revenue positions, these states can become eligible for the headroom for borrowing limit conditioned on their compliance with other two norms.

Care 2

 

Among these five states, Karnataka, Madhya Pradesh, Odisha and Telangana have the interest payment to revenue receipts ratio less than 10% as well as the debt-GSDP ratio of these four states falls below 25%. Thus, these states are entitled for 0.5% headroom over and above the fiscal deficit-GSDP target of 3%, implying the fiscal deficit–GSDP limit of 3.5% in any given year. Gujarat, that enjoyed revenue surplus for last two years, has the debt-GSDP ratio of 24.20%, below the prescribed limit of 25%. However, the interest payment to revenue receipt ratio is above 10%. As a result, Gujarat can enjoy the additional headroom of only 0.25%, making the fiscal deficit-GSDP limit of 3.25% for the state for 2016-17.

Although the other states did not comply with the revenue condition, some of the states are meeting with the other two statuses of interest payment to revenue receipt and debt to GSDP ratio. Bihar, Chhattisgarh and Jharkhand will be eligible for 0.5% flexibility in fiscal deficit as the ratios are below the ceilings, provided that they would have had the revenue surplus for the years under consideration.

Similarly, states like Andhra Pradesh, Haryana, Maharashtra and Uttarakhand exhibited debt-GSDP ratio below 25%, abiding by the criterion while Mizoram had interest payment to revenue receipt ratio below 10%, though these states failed on the revenue position compliance. Goa, Himachal Pradesh, Kerala, Punjab, Rajasthan, and West Bengal did not comply with any of the prescribed criteria under the fiscal deficit flexibility rules.

Care 3

Thus, it can be concluded that the additional headroom for borrowing, conditioned upon certain criteria, can only be enjoyed by a few states, considering the given set of selected states.

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