Pointing at Lanka-like economic crisis, RBI warns five states

Referring to the economic crisis in Sri Lanka, a Reserve Bank article on Thursday said states are showing warning signs of building stress, and the 5 most indebted ones — Punjab, Rajasthan, Bihar, Kerala and West Bengal — need to take corrective measures by cutting down expenditure on non-merit goods.

State finances are vulnerable to a variety of unexpected shocks that might alter their fiscal outcomes, causing slippages relative to their budgets and expectations, said the RBI article, prepared by a team of economists under the guidance of deputy governor Michael Debabrata Patra.

“The recent economic crisis in neighbouring Sri Lanka is a reminder of the critical importance of public debt sustainability. The fiscal conditions among states in India are showing warning signs of building stress,” it said.

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For some states, it added, shocks may increase their debt by a significant amount, posing fiscal sustainability challenges. Observing that the slowdown in own tax revenue, a high share of committed expenditure and rising subsidy burdens have stretched state government finances already exacerbated by COVID-19, the article said.

“New sources of risks have emerged in the form of rising expenditure on non-merit freebies, expanding contingent liabilities, and the ballooning overdue of discoms,” it said.

For the five most indebted states of Bihar, Kerala, Punjab, Rajasthan and West Bengal, the debt stock is no longer sustainable, as the debt growth has outpaced their Gross State Domestic Product (GSDP) growth in the last five years, it warned.

As per the article, new sources of risks have emerged from the relaunch of the old pension scheme by some states; rising expenditure on non-merit freebies; expanding contingent liabilities; and the ballooning overdue of — warranting strategic corrective measures.
“Stress tests show that the fiscal conditions of the most indebted state governments are expected to deteriorate further, with their debt-GSDP ratio likely to remain above 35 per cent in 2026-27,” the authors said.

The central bank, however, said the views expressed are those of the authors and do not necessarily reflect the views of the Reserve Bank of India.

As a corrective measure, the article suggested that the state governments must restrict their revenue expenses by cutting down expenditure on non-merit goods in the near term.
In the medium term, it added the states need to put efforts towards stabilising debt levels.

It also recommended large-scale reforms in the power distribution sector would enable the discoms (power distribution companies) to reduce losses and make them financially sustainable and operationally efficient.

In the long term, increasing the share of capital outlays in the total expenditure will help create long-term assets, generate revenue and boost operational efficiency.

Alongside, state governments need to conduct fiscal risk analyses and stress test their debt profiles regularly to be able to put in place provisioning and other specific risk mitigation strategies to manage fiscal risks efficiently.

(With Agency inputs)