The finance commission (FC) had recommended that borrowings by states should be linked to the size of the gross state domestic product (GSDP). However, this often results in information asymmetry as GSDP numbers of states undergo revisions like any other macro number. Given the borrowings incentivisation, it also results in states projecting ambitious GSDP numbers during the Budget presentations that are only revised downwards later. Under the circumstances, there is a need to devise a better formula for setting state borrowings and delinking them from advance GSDP estimates, says a research note.
In a report, Dr Soumya Kanti Ghosh, group chief economic adviser of State Bank of India (SBI), says, "States that are better behaved may be rewarded in terms of an increase in size of the permissible borrowing in the subsequent year where permissible borrowing is scaled up by the lower advance borrowings. This scale up can also come at a rate lower than the market rate of interest."
"A similar scheme could be envisaged for states that are borrowing more, with a scale down in the permissible borrowing or the higher advance borrowings may be resorted to only at a rate that is higher than market rate of interest. Another possible solution could be linking of the state borrowing to its own tax revenue," he added.
As a logical corollary, states get access to higher advance borrowing based on their higher GSDP Budget estimate (BE) projections. Certain states including West Bengal, Maharashtra, Andhra Pradesh, Chhattisgarh, Uttar Pradesh, Tamil Nadu and Rajasthan have borrowed higher than 3% of their actual GSDP in either or all the years ending FY20-21.
Market borrowing by states for FY20-21 shows that Tamil Nadu has the highest share in total market borrowing by states, followed by Uttar Pradesh, Karnataka, Maharashtra, West Bengal and Rajasthan. On the other hand, the North Eastern states had a small share in overall market borrowing.
If we look at the data for the past three years, we can clearly see that many states witnessed a decline in the actual GSDP compared to the GSDP as given in their BE, SBI says.
According to Dr Ghosh, the actual amount of over borrowing in FY20-21 would be much higher than that shown by revised estimates (RE) as SBI believes that the actual GSDP of the states would be revised downwards.
He says, "If we estimate the GSDP of states based on their share in their total GDP, the over borrowing would amount to at least 50% higher than that based on the GSDP revised estimates. However, FY20-21 could still be an aberration, given the onset of the pandemic."
SBI says, even if it considers the additional borrowing conditions set by the FC for the years, it finds that the trend is only getting more broad-based.
Conditional limit on state borrowings finds echo in the 15th finance commission recommendations also, the report says, adding, "It may be noted that in FY21-22, based on the 15th finance commission's recommendation, the Union government had allowed the states’ net market borrowing of up to 4% of GSDP, additional 0.5% of GDP conditional borrowing on fulfilment of power sector reforms. Besides, the total amount of grants given to local bodies has increased. Of the Rs2.2 lakh crore grants permitted for FY21-22, only Rs1.54 lakh crore is unconditional and the remaining Rs67,105 crore for local bodies is conditional and based on reform of urban local bodies."
Coming to the Union government's revenues, tax collection figures in the first quarter (Q1) of FY21-22 are now 36% of the budgeted numbers, showing a higher percentage than was normally observed even before the pandemic.
"This provides hope that devolution to states will remain robust. Rs1.17 lakh crore has already been transferred to states as devolution by the Union government till Q1FY21-22. With states already garnering 28% of budgeted goods and services tax (GST) collections in April to July 2021, it is expected that the extra borrowings of Rs1.59 lakh crore which the Union government has estimated in the 43rd GST council meeting to compensate the states for GST may be reduced," the report says.
According to SBI, in the coming months, GST (goods and services tax) collections are expected to improve and states would have additional resources at their disposal to meet their financial requirements.