The Centre has decided to lift a virtual freeze on fresh market borrowings by states with large off-Budget liabilities. It will, however, strike off at least 25 basis points (bps) from the net base borrowing ceiling (NBC) of 3.5% of gross state domestic product (GSDP) of these states in FY23.

The off-Budget liabilities will be counted only from FY22 onwards. The balance debt, so estimated, will be brought above the line over the three years to FY26 in equal tranches.

In an earlier directive to states, the Centre had said their entire off-Budget liabilities of FY21 and FY22 will be adjusted against the NBC for FY23. If implemented, this policy would have severely restricted the plans of some states like Telangana, Punjab and Kerala to raise funds through state development loans (SDLs) in the current financial year and thereby their capital expenditures. The Centre’s stance has already led to some delay in approvals of annual SDL limits of states, which are usually in place in April in any financial year.

The tightening of the regulation on states’ borrowings by the Centre is in view of the rising yields on SDLs and the rate hike cycle started by the Reserve Bank of India, which could raise the cost of general government borrowings.

High cost of government borrowings could inflate public debt, already at a precarious level, further.

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

“Borrowings by state public sector companies/corporations, special purpose vehicles and other equivalent instruments, where principal and /or interest are to be serviced out of the state budgets and/or by assignment of taxes/cess or any other state revenue, shall be considered as borrowings made by the state itself for the purpose of issuing the consent under Article 293(3) of the Constitution of India.”

According to Crisil Ratings, off-balance sheet borrowings by all states may have reached a decade-high of about 4.5% of gross domestic product (GDP), or about Rs 7.9 trillion, in FY22.

As the Covid pandemic hit state tax revenues, the Centre not only raised their borrowing limit by 2 percentage points to 5% of GDP in FY21 but also allowed them to borrow up to 75% of the annual threshold in April-December of the year. A similar relaxation was available in FY22 as well, when the limit was reduced to 4.5%.

Sensing that states could cut back on capital expenditure, the Centre released the Goods and Service Tax compensation of about Rs 86,912 crore to states on May 31, including arrears and April-May aid. The Centre had to dip into its own revenue pool to raise Rs 62,000 crore for this purpose.

Analysts said the delays in market borrowings will prove costlier for states as the Reserve Bank of India (RBI) will likely further increase interest rates in the coming months.

As many as nine states – Assam, Chhattisgarh, Himachal Pradesh, Madhya Pradesh, Nagaland, Sikkim, Telangana, Uttar Pradesh and Uttarakhand – which had initially indicated they would borrow during April-May FY23, are yet to access the SDL market. Possibly, these states are still awaiting the approval from the Centre, rating agency Icra said. Despite indicating that they will participate in the SDL auction held on May 31, Punjab (with borrowings plan of Rs 1,500 crore) and Telengana (Rs 3,000 crore), did not participate.

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

“We estimate that tax devolution to the states will be Rs 1.1 trillion higher than budget estimate for FY23. Based on this, the monthly devolution amount could be enhanced by Rs 10,000 crore/month above the amount transferred in April 2022. This would ease the cash flows of the states, especially those that may not have received their borrowing permission as of mid May. An early release will help accelerate spending while back-ended release may only lead to lower borrowings in Q4, which won’t serve to accelerate the revival in economic activity,” Icra chief economist Aditi Nayar said.