Lending restrictions eased for high-debt states

The Center has decided to lift the virtual freeze on fresh market borrowings by states with large off-budget liabilities. However, it will reduce the net base lending limit (NBC) of these states by at least 25 basis points (bps) of 3.5% of Gross State Domestic Product (GSDP) in FY13.

Off-budget liabilities will be calculated from FY22 onwards only. The remaining loan, thus projected, will be brought over the line in equal installments over three years till FY26.

In an earlier directive to states, the Center had said that their entire off-budget liabilities of FY 2011 and FY 2012 would be adjusted against NBC for FY 2013. If implemented, this policy would severely restrict the plans of some states like Telangana, Punjab and Kerala to raise funds through State Development Loans (SDLs) in the current financial year and thus their capital expenditure. The Centre’s stand has already led to some delay in the approval of states’ annual SDL limits, which usually happen in April of any financial year.

The tightening of regulation on state lending by the Center comes in the wake of rising yields on SDLs and the rate hike cycle initiated by the Reserve Bank of India, which could raise the cost of general government borrowing.

The high cost of government borrowing could further increase public debt to an already precarious level.

In a letter to the state finance ministries on March 31, 2022, the Union Finance Ministry wrote:

“Borrowing by State Public Sector Companies/Corporations, Special Purpose Vehicles and other equivalent instruments, where the principal and/or interest is to be repaid out of the State Budget and/or by assignment of taxes/cess or revenue of any other State, India Under Article 293(3) of the Constitution of India, it is treated as a loan taken by the State for the purpose of issuing consent.

According to Crisil Ratings, off-balance sheet lending by all states in FY22 could reach a decade high of around 4.5% of Gross Domestic Product (GDP) or around Rs 7.9 trillion.

As the Covid pandemic hit state tax revenues, the Center not only raised their borrowing limit by 2 percentage points to 5% of GDP in FY2011, but also raised them to 75% of the annual limit in April-December of the year. Borrowing up to Rs. A similar exemption was also available in FY22, when the limit was reduced to 4.5%.

Noting that states can cut capital expenditure, the Center released Goods and Services Tax compensation of around Rs 86,912 crore to states including arrears and April-May assistance as on May 31. The Center had to dip into its own revenue pool to raise Rs 62,000 crore for this purpose.

Analysts said the delay in market borrowing would prove costly for the states as the Reserve Bank of India (RBI)reserve Bank of IndiaInterest rates are likely to increase further in the coming months.

Nine states – Assam, Chhattisgarh, Himachal Pradesh, Madhya Pradesh, Nagaland, Sikkim, Telangana, Uttar Pradesh and Uttarakhand – that had initially indicated they would borrow during April-May FY23 are yet to reach the SDL market. Rating agency Icra said that probably these states are still waiting for the approval of the Center. Despite indicating that they would participate in the SDL auction held on May 31, Punjab (with a borrowing plan of Rs 1,500 crore) and Telangana (with Rs 3,000 crore) did not participate.

Telangana, which has accused the Center of not allowing borrowing, finally got ad-hoc approval to borrow Rs 4,000 crore from the market on June 3. The state’s full-year lending plan is yet to be approved by the Centre.

“We estimate that the tax devolution to the states will be Rs 1.1 trillion more than the FY 2013 budget estimate. Based on this, the monthly transfer amount can be increased to Rs 10,000 crore per month from the amount transferred in April 2022. This will ease the cash flow of the states, especially for those states which may not have got permission to borrow till mid-May. “Early releases will help accelerate spending, while back-ended releases may only lead to lower borrowing in Q4, which will not act as a boost to economic activity,” said Aditi Nair, chief economist, ICRA.