Sri Lanka Crisis: Are Indian states on the same path to economic distress?

The RBI, in a report in June 2022, said that several Indian states are posting worrisome numbers, mainly due to populist measures

Sri Lanka, once one of the most prosperous nations in India's neighbourhood, has been in the news for all the wrong reasons of late. Food and fuel scarcity, skyrocketing inflation, civil unrest and finally, former President Gotabaya Rajapaksa fleeing the country on July 13, the sequence of events brought forth the country's grim economic and political reality. However, are some Indian states taking the same policy decisions that landed the island nation into trouble?

What went wrong with Sri Lanka?

The Sri Lankan government, under the Rajapaksa brothers, Gotabaya and Mahinda, came into power in 2019. To fulfil the election promises and alleviate the tax burden of the citizens, the government decided to opt for short-term solutions like providing freebies etc.

On top of that, the Sri Lankan government also decided to ban the use of fertilisers and opted for organic farming, pulling the agricultural output down considerably. At the same time, the country’s tourism sector was severely hit by Covid-19. All these factors led to a sharp fall in the government's revenues.

According to the data by International Monetary Fund (IMF), the Sri Lankan government's general revenue as a per cent of the gross domestic product (GDP) fell from 14.1 per cent in 2016 to 9.2 per cent in 2020. In 2021, it stood at 8.9 per cent.

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This led to a rise in the fiscal deficit. The government debt was 79 per cent in 2016. By 2020, it had breached the 100 per cent-mark and stood at 101.2 per cent. In 2021, the debt stood at 107.2 per cent.

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The government issues repayment guarantees to enable the public sector enterprises to take loans. These are issued as limits under the Fiscal Management (Responsibility) Act. It was revised to 15 per cent in 2021.

What is the situation in India?

Indian economy is in better shape compared to its peers. Where the debt to GDP ratio is over 100 per cent in advanced economies (107.2 per cent in Sri Lanka), it is 73.95 per cent in the case of India.

India's external debt to GDP ratio is even lower at 19.9 per cent. In the US, this ratio stands currently at 127 per cent.

However, in a June 2022 report, the RBI said that several states are posting worrisome numbers, mainly due to populist measures.

How are Indian states performing?

Several Indian states are under severe economic stress. According to official data, Rajasthan, Punjab, and Tamil Nadu have the highest revenue deficit at 3.64 per cent, 2.64 per cent and 2 per cent of the gross state domestic product (GSDP), respectively.

Telangana, a relatively new state, has already slipped into the deficit zone with a revenue deficit of 0.66 per cent.

Telangana, surprisingly, has the highest growth rate of outstanding liabilities between 2015 and 2020 at 30.6 per cent. Kerala follows it at 19.2 per cent.

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With the revenue falling, most states government are forced to compromise on the welfare schemes to meet the committed expenditure, including interest payments, pension and salaries. In this regard, Punjab, Kerala, Tamil Nadu, Rajasthan and West Bengal are India's worst-performing states.

For the period between 2017 and 2020, the committed expenditure of these states as a per cent of the revenue receipt is higher than the national average of 36 per cent.

The RBI report also stated that the total outstanding liabilities of the four states, namely Punjab, Rajasthan, West Bengal and Kerala, were higher than the national average of 32.1 per cent. Too much debt restricts the state's ability to take more welfare initiatives.

Telangana also has the highest outstanding guarantees at 11.8 per cent of the GSDP. The national average stands at 6.6 per cent.

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It is the least for Gujarat and Karnataka at 0.15 per cent and 1.44 per cent, respectively.

The official data has also shown how the off-budget borrowings by several states have skyrocketed since 2019. Against the national average of 0.7 per cent, Telangana has an off-budget borrowing of 4.65 per cent of its GSDP.

To control the surge, the government of India has set a cap of 3.5 per cent of GSDP or Rs 8.57 trillion on off-budget borrowing.

The data also showed that Punjab has the highest share of interest payments in its revenue expenditure. In 2019-20, the interest payment of Punjab was almost double the national average of 12.6 per cent at 23.2 per cent. West Bengal, Kerala and Tamil Nadu were also above the national average at 19.5 per cent, 18.3 per cent and 15.2 per cent, respectively.

On the other hand, only a handful of Indian states like Uttar Pradesh, Gujarat and Karnataka have a capital outlay higher than the national average. Against the average of 13.6 per cent, the outlay to expenditure per cent stood at 18.5 per cent, 17.8 per cent and 16.9 per cent for UP, Gujarat and Karnataka, respectively.

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Punjab and Kerala were again the worst performers at 7.8 per cent and 8.1 per cent. Notably, the states with a better capital outlay have a better chance to meet the expenses during the period of distress.

While Uttar Pradesh and Gujarat have revenue surplus, Telangana and Punjab have revenue deficits. Also, UP is the only state in the country with a gross fiscal surplus. Tamil Nadu, on the other hand, has the highest gross deficit.

While India as a whole might not be in danger currently, several state finances show signals of severe distress. The precarious situation of finances owing to populist measures in the states like Punjab and Telangana might as well ring alarming bells in the ears of their administrators.