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December 31, 2018

Indian Economy: Debt wish in the states

The Fiscal Responsibility and Budget Management Act, 2003, brought a measure of fiscalrectitude to states. But the trend changed with the Ujwal Discom Assurance Yojana (UDAY),farm loan waivers, and pay commission hikes, and states’ debt ratios are on slippery groundagain. In this issue, we analyze the debt ratio of states for the past five years. The debt ratiomeasures a state’s debt against its income, or gross state domestic product (GSDP). For this, wecompared the non-special category states (defined by the Reserve Bank of India or RBI),excluding Andhra Pradesh and Telangana, as their bifurcated debt ratios are unavailable priorto fiscal 2016. For our analysis, we classify the states based on their debt ratio and analyze whatdrives their debt ratio using the parameters of the debt sustainability equation. The debtsustainability equation requires that,


Change in debt ratio (∆D) = Primary deficit + [(Nominal interest rate - Nominal growth rate) ×Debt ratio]


Simply put, this equation implies that for debt to be sustainable, over time, the state must run aprimary account surplus and/or grow at a faster rate than the nominal interest rate. Based onthe equation, we find that in case of most states, an increase in the primary deficit was the majorcause for worsening of the debt ratio. However, the nominal GSDP growth rate is higher than1 interest rates for all the 16 states. Below is a snippet on the categorization of the states and thefactors that led to the movement in their debt ratios


Very high debt ratio (>30%) states: Punjab, Rajasthan, and Kerala - For Punjab and Rajasthan,the debt ratio worsened after the state governments took over the discom debt under UDAY. Incase of Kerala, a slowdown in the GSDP growth, which impacts the denominator of the debtratio, was the main reason for the worsening debt ratio.


Moderate-to-high debt ratio (20%-30%) states: Bihar, Haryana, Jharkhand, Madhya Pradesh,Tamil Nadu, Odisha, Goa, West Bengal, Uttar Pradesh, and Gujarat - For most states, includingBihar, Haryana, Jharkhand, Madhya Pradesh and Tamil Nadu, the debt ratio worsened owing toan increase in primary deficit, largely on account of UDAY. On the other hand, debt ratiosimproved over the period for West Bengal and Gujarat as they were able to rein in their primarydeficit.


Low debt ratio (<20%) states: Chhattisgarh, Karnataka, and Maharashtra - Maintaining arange-bound primary deficit while sustaining high growth rates has helped these states inkeeping their debt ratios low.


Thus, the focus of most states witnessing an explosive debt ratio should be on improving theirprimary balances. This can be done by shoring their tax revenue, as for most states, the share ofown tax revenue in GSDP has been declining.