An analysis of sustainability of states debt

Abstract

There is growing awareness today in India of the urgent need to contain public debt at sustainable levels at the level of both the Centre and states. In recent years, the debt problem at state level has become the priority area of concern. In addition to budgetary debt, States have also increasingly resorted to off-budget borrowings through guarantees. In the months to come, some states may well find financial markets unwilling to absorb their securities. The repercussions could extend by contagion to all states. Studies on debt sustainability in the Indian context have tended to be confined to the Central Government, or to state finances only at a consolidated level. State-wise analysis is conspicuous by its absence. While the issue of debt sustainability is a concern across all the states, their heterogeneity in terms of size, level of income, and their financial position measured by various fiscal indicators and ability to raise resources on their own, calls for varied policy initiatives. This paper attempts to provide exactly such a state-specific assessment of sustainability status, and the kind of corrective action called for in each. Conventional wisdom offers three distinct approaches to assess the sustainability of fiscal policy, viz., Domar Stability Condition, Sustainability Indicators and Present Value Budget Constraint. According to the received wisdom, fiscal sustainability rule requires real growth rate to exceed real interest rate and primary balance to be non-negative for the debt/GD Pratio to be stable. The necessary condition is that real interest rate (r) is lower than real GDP growth (y) and the sufficient condition is that adequate primary surplus is maintained to finance debt services. An attempt has been made to evaluate the Domar Stability Condition for each of the State governments. The time period for this analysis is from 1990-91 to 2003-04. At the start, the growth rates of debt and GDP have been shown in Graph 3. One of the conditions for debt sustainability requires that the growth of income should be greater than that of debt. It is evident from the Graph that growth of consolidated debt of States was higher than that of growth of income during 1997-98 and 2003-04 showing the sustainability of their debt. Further analysis of each individual States (Special and non-Special) debt position is given in Table 5. It is clearly evident that each of the individual States confirm to the Domar conditionality indicating their sustainability except for one State. It is also evident that for most of the States the condition has weakened during the period 1996-2001, though recovery in the condition has been noticed during the period 2001-2004.On the basis of the findings, broad public policy initiatives aimed at restoring and consolidating debt sustainability have been listed in the last two chapters.