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States Part 2: Issues regarding state finances

HDFC Bank, October 2023

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Key highlights

States budgeted to spend more in FY24 spending so far

States’ fiscal health in FY23 FY24 Gross Borrowings
FY24 Capex is gaining traction, Revenue
States’ fiscal deficit narrowed to Pegged at INR 9.4 lakh Cr vs. INR
FY24 fiscal deficit budgeted at spending lagging behind last year’s
2.8% of GDP in FY23 . 7.6 lakh in FY23
3.2% of GDP level

Some medium-term issues:

Issue #3) Adjustment of off-
balance sheet borrowings:
Issue #1 Return to old pension Issue #2: End of GST
scheme compensation cess:

likely to result in significant future States need to streamline Positive for fiscal transparency,
fiscal cost alternative resources/improve although could impact fiscal space
efficacy of tax collections in states with higher off-balance
sheet spending

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States’ FY23 Fiscal Performance: Overall deficit reduced, interstate variations remain

States’ fiscal deficit narrowed to 2.8% of GDP in FY23 from an average of 3.4% b/w FY21-FY22.

• Out of the 19 states in our sample set, 14 undertook fiscal consolidation in FY23 vs. FY21-FY22 average.

• The narrowing in the fiscal deficit came on the back of both an increase in revenues and some compression in expenditure.

• To recall, fiscal deficit shot up in FY21 due to pandemic related spending and pressures on revenue collections.

However, fiscal situation deteriorated in Bihar, H.P. and Punjab

Bihar Government collected 87% of its BE receipts in FY23, while

expenditure was largely in line with the target.

In Himachal, fiscal deficit overshot BE at the margin. As per the

15th Finance Commission, state’s GST performance is lagging.

Punjab- Higher than BE spending on salaries, pensions. State was

among the highest freebee spenders (RBI)

Odisha recorded a surplus in FY22 due to a sharp

increase in non-tax revenues (mainly mining)
Source: RBI, CEIC, CAG, HDFC Bank

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FY24: Higher fiscal deficit budgeted

States’ fiscal deficit is estimated to increase to 3.2% of GDP in FY24 from 2.8% in FY23. States with fiscal expansion plans and high debt are at risk

States at Risk- Rajasthan, Kerala, W.Bengal, U.P, Jharkhand, Punjab

States that are attempting to improve– H.P., AP, Tamil Nadu

States with good fiscal health- Gujarat, Karnataka, Maharashtra, Odisha

Source: RBI, CEIC, CAG, HDFC Bank

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Issue #1- Old vs. New Pension Scheme

After adopting NPS earlier Rajasthan, Chhattisgarh, Jharkhand & Punjab have shifted back to OPS in FY23. Himachal
opted more recently in April 2023.

Some other states like Maharashtra have also indicated to move to OPS.

OPS (Old Pension Scheme) NPS (National Pension Scheme) OPS (Old Pension Scheme)

Old New
Fixed.
Govt employees can opt for either 50%
Variable.
Payments to Retirees of last basic pay or average of last 10
Linked to market returns
months pay. This is topped up with a
dearness allowance
Eligibility Government employees Both- Private and Public

60% of corpus tax free on maturity, 40%

Tax Liability on Retirees No
taxable (invested in annuities)

Entire burden on states. Liabilities

Employees contribute 10% of basic pay,
Fiscal Cost continue to rise with revision in
employers can contribute up to 14%
dearness allowance

Source: RBI, NPS, HDFC Bank

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Why OPS looks attractive to states & employees?

Benefits for States Benefits for State Govt. employees

❑ Low near term expenditure: Under OPS, pension payments of ❑ Fixed pension payments- 50% of basis /average of last 10 month pay
retirees begin only after retirement, i.e. payments are deferred till
retirement ❑ More cash in-hand for employees- no monthly contribution

❑ Better cash flow: No monthly contribution under OPS by states ❑ No taxation on pension payments.

Pension Expenditure rose sharply after states implemented States re-opting for OPS have budgeted for lower pension payments
recommendations of 7th Pay commission in FY24

Source: CEIC, RBI, HDFC Bank

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Return to OPS: near term gain, long term fiscal pain

Pension burden is likely to be 4.5x under OPS vs NPS (RBI Estimate)

States’ Projected Pension Outgo

Increase in retiree population Rise in Pension payments
(% of GDP)—NPS vs OPS
Over the next two decades, proportion of old age population is projected to increase
across sates

Shift to OPS= Fiscal savings likely to be offset by a higher deficit in future

Savings

Impact on Fiscal Balance in

shifting back to OPS
(% of GDP)
Deficit
While OPS could improve annual cash flow of states, full funding of scheme
is likely to cause fiscal stress in future.

Source: RBI, Economic Survey, HDFC Bank

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Issue #2- End of GST Compensation Cess: likely to strain states’ revenue?

GST Compensation Cess

The Promise The problem now

▪ The Central Government promised to compensate states for five years (Jul ▪ After transition period ended in Jun-22, several states asked for an extension
17-Jun 22) for revenue shortfall arising because of GST adoption. citing revenue losses.

▪ States were compensated for the difference between the projected revenue ▪ As per the RBI, states with relatively high dependence on compensation cess
based on 14% annual growth with 2015-16 as the base year and the actual (Punjab, HP, UK) are likely be impacted.
GST revenue.

Without compensation cess, GST revenue would have fallen short

of projected revenue with 14% YoY growth

Source: RBI, HDFC Bank

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Dissecting states’ revenue sources

States’ Revenue
An end to GST compensation cess is likely to put a strain on states’ revenues. They need to focus on increasing compliance, reducing leakages
and widening of tax bases.

Revenue Receipts Break up of states (% of total)

Pre-GST Post-GST
Share of states’ own tax revenue has gone
FY13-FY17 Pre-Pandemic Pre-Pandemic
Post-Pandemic
down
(Average) (FY22-FY23 Avg)
(FY18-FY20 Avg) (FY2-FY23 Avg)
Tax Revenue 73.8 73.3 67.6
State's Own Tax Revenue 48.8 47.0 45.9
Taxes on Property and Capital Transactions 6.0 5.3 5.4 Reflection of a VAT cut on fuel?
Taxes on Commodities and Services 42.5 41.4 40.2
Sales Tax 30.8 13.1 10.5
State Excise 5.8 5.7 6.3
State Goods and Services Tax NA 18.0 19.5 SGST constitutes ~20% of states’ revenue
Share in Central Taxes 25.0 26.3 21.8

Non-Tax Revenue 26.2 26.7 32.4 States’ reliance on grants (inc. GST
State's Own Non-Tax Revenue 8.9 8.6 8.0 compensation cess) from Central
Government has risen. Likely to come
Grants from the Centre 17.2 18.1 24.3
down as GST compensation cess ends

Source: RBI, HDFC Bank

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Issue #3- Net Borrowing Ceiling (NBC): Aiming more transparency

Borrowings by state owned enterprises Off-balance Sheet ----On-balance sheet Impact on states

• State owned enterprises/SPVs increased borrowings • C.Govt directed states to shift off-balance sheet • Net borrowing limit fixed at 3.0% of GDP for FY24
since the pandemic. borrowings on state government’s balance sheet.
• Fresh borrowings to reduce by the balance sheet
• These are guaranteed by State Governments. • Liabilities incurred since FY22 to be considered. adjusted amount.

• While these borrowings aren’t reflected in states’ debt, • This is to be done over a period of four years, i.e. b/w
servicing burden (inc. principal) is borne by states. FY23 & FY26.

(in INR, Cr) Off-budget Liabilities Impact on borrowing Off-budget Liabilities

(FY22) (FY23) (FY23)
Borrowing above
Andhra 8,000-9,000 3,600 1,300
NBC limit:
Telangana 35,000 8,800 - • 0.5% of GDP subjected
to power sector
T.Nadu 594.88 - 746 reforms

U.P. 19,496 8,000 4,048

Kerala 14,100 3,578 2,769

Source: Media Articles, HDFC Bank

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FYTD Fiscal trends: Capex better than the last year

Revenue expenditure by states is in line with last year’s Encouragingly, capex has picked up pace in FY24. Revenue receipts collection is lagging behind last
trend. year’s trend.
Welfare spending by poll-bound states could led to an increase Andhra, Telangana, M.P., Kerala are driving states’ capex
in revenue spending

Based on fiscal performance of 15 major states

Source: RBI, CEIC, CAG, HDFC Bank

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Financing of the fiscal deficit

States’ FY24 Fiscal Deficit

INR 9.6 lakh Cr (3.2% of GDP)

How the fiscal deficit is financed?

Net Market Borrowings Other financing sources

Loans from central Government,
INR 6.5 lakh Cr LIC, NABARD, Provident fund
(67.5% of fiscal deficit) receipts, etc.

Total States’ Borrowings

Net Market Borrowings Repayments Gross Market Borrowings

INR 6.5 lakh Cr INR 2.9 lakh Cr INR 9.4 lakh Cr

Source: RBI, CEIC, HDFC Bank

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States’ borrowing in FY24: Assumptions

States’ Fiscal Deficit

•Aggregate states’ fiscal deficit estimated at 3.2% of GDP in FY24 vs. 2.8% of GDP in FY23

But fiscal performance & borrowings could vary across states

•Punjab, H.P., M.P. to record higher fiscal deficit

Nominal GDP Growth

•FY24 nominal GDP growth estimated at 10.5% YoY (HDFC Estimate)

Factors that could impact borrowings

•Interest free capex loans by Central Government, Power Sector Reforms linked borrowings, Adjustment of
off-balance-sheet borrowings

States’ Borrowing
•Net market borrowings expected at 67.5% of FY24 fiscal deficit (INR 6.5 lakh Cr).
• With redemptions at INR 2.9 lakh Cr, gross market borrowings expected at INR 9.4 lakh Cr
•Rest of the deficit to be financed by loans from the Central Government, LIC, NABARD, etc, & Provident
Funds.

Source: RBI, CEIC, HDFC Bank

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States’ borrowing in FY24

Gross SDL issuances estimated at INR 9.4 lakh Cr for FY24.

States have borrowed INR 3.80 lakh so far

Financing of State's Fiscal Deficit

(in INR, lakh Cr) FY20 FY21 FY22 FY23 FY24-E
Gross Fiscal Deficit 5.2 8.0 6.7 7.6 9.6

Gross Market Borrowings 6.3 8.0 7.0 7.6 9.4

Repayments 1.5 1.5 2.1 2.4 2.9
Net Market Borrowings 4.9 6.5 4.92 5.2 6.5

Other sources of financing

Loans from Centre 0.1 1.4 1.44 0.75
Loans from LIC, NABARD, NCDC, SBI and Other
Banks 0.2 0.1 0.18 0.26
Provident Funds, etc. 0.4 0.4 0.37 0.38
Deposits and Advances 0.4 0.2 0.085 -0.06
Others -0.8 -0.5 - -
Note: The fiscal deficit and borrowings are an aggregate for all states.
Other sources of financing – data for FY22, FY23 is RE numbers from RBI. Gross & net market
borrowings for these years are actual numbers

Source: RBI, CEIC, HDFC Bank

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States’ Fiscal Health: Medium Term Risks & Positives

Issues Positives

Return of Old Pension Scheme---high Improvement in quality of

deficit and debt in future spending—focus on capex in some
states

“Freebies” remains a risk for quality of

spending and fiscal consolidation
More transparency–off balance sheet
borrowings included in Net
Borrowing Ceiling
End of GST compensation cess—pressure
on revenue for some states

Power sector: Poor performance of Faster growing states—might benefit

DISCOMs. ~ 40% of state’s contingent from better revenue collection
liabilities are due to power sector (RBI)

Source: RBI, HDFC Bank

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Treasury Economics Research Team

Disclaimer: This document has been prepared for your information only and does not constitute any offer/commitment to transact. Such an offer would
be subject to contractual confirmations, satisfactory documentation and prevailing market conditions. Reasonable care has been taken to prepare this
document. HDFC Bank and its employees do not accept any responsibility for action taken on the basis of this document.

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