Sub-national Debt Management Indian Experience Alok Chandra Director, Ministry of Finance, India 27 June 2008
Structure Part A: Institutional Approaches to regulations of Sub-national Borrowings Part B: Regulation of Borrowings by States in India Part C: Issues in Debt Sustainability of Subnational
Part A Institutional Approaches to regulations of Sub-national Borrowings
Background Decentralization and urbanization : expanding trend across countries Sub-national entities responsible for delivering a wide range of local services and undertaking investment in local infrastructure. To fund capital expenditure and deficit over current account.
Rationale for Regulation of Subnational Borrowings Soft budget constraints and increasing indebtedness of sub-national governments have deleterious macro-economics effect. Short run: monetary expansion, inflation, interest rate and balance of payments. Medium and short term: crowd out private investment and reduce economic growth; intergeneration equity effect, (especially if the social rate of return is low and sub-national govts. cannot internalize all the benefits).
Agency Problem Principal agent relationship between central government, sub-national entities and lenders Hidden action Hidden information
Approaches to regulations of Sub-national Borrowings Market Discipline Administrative Controls Rules based approach Cooperative arrangements among different tiers of government
Market Discipline No limits on sub-national borrowings set by central Govt. Most desirable, if it is strict However, rarely achieved even in federations with well developed financial markets (because of agency problem) Conditions for effectiveness of market discipline (a) Free and open access to financial market with no mandatory investment restrictions. (b) Adequate credit information, e.g. debt outstanding and capacity to pay (c) Absence of moral hazard-no perceived chance of bail-outs (d) Sensitivity to market signals: interest rate and the possibility of market exclusion Canada is very close to market discipline approach.
Administrative controls Direct controls (a) require the central govt s approval for each credit operation proposed by sub-national govt., or (b) prohibit sub-national govts from accessing markets direct (upto March 2005 in India) Prohibition on sub-national govt. access to foreign capital markets. Provides flexible fiscal policy, but implied approval by central govt. introduce explicit or implicit guarantee.
Prohibition on sub-national govt. access to foreign capital markets Change in external debt have direct impact on macro economic variables (exchange rate, foreign exchange reserves, money supply) Control for stabilization States approach in fragmented manner International lenders require federal govt. guarantee
Rule Based approach Standing rules in constitution or statutes Restrictions may take the form of (i) restriction on consolidated budget deficits (ii) indicators of debt servicing (iii) debt stock Improves credibility of fiscal policy Restrictions do not apply to off-budget items (e.g. guarantees), debt could accumulate. Adopted to different degrees in Brazil, Korea, Japan, Spain and U.S
Co-operative Arrangements Negotiations between federal and sub-nationals design borrowing controls. Combines individual advantages of of other three approaches. Hybrid nature may produce flaws of other approaches. Undermine control of central govt., soften budget constraints, bargain for central transfers
Part B Regulation of Borrowings by States in India
Partners in State Debt Government of India Management Decides Resource Allocation, Interest Rates, Policy on Consolidation of Central Debt, Debt Swap Scheme, Buyback of Debt. Reserve Bank of India Raises Market Borrowing, Acts as Registrar, Makes debt service payments on market loans, Invests surplus cash, Provides Ways & Means, Administers Consolidated Sinking Fund And Guarantee Redemption Fund.
CAG/CAAA Partners in State Debt Management( cont.) Maintains accounts and makes debt service payments on loans from Line Ministries. State Governments Decide Policy on debt management and its execution, Decide institutions from who to borrow, rate at which to borrow Pay debt service costs and Maintains debt and guarantee data.
Basic Features Borrowing of States reflects the fiscal deficits of the State Government. Government of India regulates borrowings of the States under Article 293 of the Constitution Even within the overall borrowing ceiling instruments for borrowing are also fixed in consultation with the State Government and the Planning Commission
Basic Features(cont.) Instruments available for borrowings are (i) NSSF (ii) Open Market Borrowings (iii) Negotiated Loans (iv) Provident Fund and other accretions in the public account.
Fiscal Deficit of States as % of GDP 1999-00 4.61 2000-01 4.14 2001-02 4.10 2002-03 3.97 2003-04 4.41 2004-05 3.40 2005-06 2.56 2006-07 1.69 2007-08(RE) 2.29 2008-09(BE) 2.11
Outstanding Liabilities of State Govts. (As at end-march) Year Amount Annual Growth Debt/GDP (Rs. billion) (Per cent) 1991 1,282-22.5 2000 5,095 27.5 26.1 2001 5,941 16.6 28.3 2002 6,907 16.3 30.3 2003 7,864 13.9 32.0 2004 9,134 16.1 33.0 2005 10,292 12.7 32.9 2006 11,679 13.5 32.7 2007(RE) 12,687 8.6 30.8 2008(BE) 13,787 8.7 29.8 Source :RBI
Composition of Outstanding Liabilities of State Governments (As at end-march) (%) Item 1991 2000 2005 2006 2007(RE) 2008-(BE) 1. Internal Debt On which: 15.0 24.6 57.8 59.8 61.5 62.7 (i) Market Borrowings 12.2 14.8 20.7 19.6 19.1 19.5 (ii) Special Securities issued to NSSF - 5.0 27.4 31.3 33.5 34.7 (iii) Loans from Banks and FIs 2.0 3.4 6.6 6.2 6.7 6.8 2. Loans and Advances from the Centre 57.4 45.2 15.6 13.4 12.5 12.0 3. Public Accounts (I to iii) 26.8 29.9 26.6 26.6 25.9 25.1 (i) Small Savings, State PF etc. 13.2 15.8 14.2 13.8 13.5 13.4 (ii) Reserve Funds 3.7 3.9 5.1 5.4 5.4 5.2 (iii) Deposits & Advances 10.0 10.2 7.3 7.4 7.0 6.5 4. Contingency Fund 0.8 0.3 0.1 0.1 0.1 0.1 Total Liabilities ( to 4) 100.0 100.0 100.0 100.0 100.0 100.0 Total Liabilities (Rs. billion) 1,282 5,095 10,291 11,579 12,687 13,787
Regulation of Borrowings by States in India TFC has recommended overall cap on borrowings to be achieved by States by 2009-10 - 3% of GSDP Debt- GDP ratio of 30.8% to be achieved by States by end-march 2010. Ratio of interest payments to revenue receipts at 15% to be achieved by 2009-10 State govts. to approach the market directly.
Regulation of Borrowings by States in India(cont.) For fiscally weak states, centre can borrow on behalf of such states, but interest rate should remain aligned to the marginal cost and borrowing for the centre. External loans to be passed to states on back-toback basis, exemption to Special category States. States to set up sinking fund for amortization of all loans,outside consolidated funds of states and public account. Enactment of FRL
Core recommendations of TFC which need to be incorporated in FRBM of States Eliminating revenue deficit by 2008-09 Reducing fiscal deficit to 3% of GSDP Bringing annual reduction targets of revenue and fiscal deficits Bringing out annual statement giving prospects for the State s economy and related fiscal strategy Bringing out special reports along with the budget giving details of number of employees in govt, public sector and aided institutions and related salaries.
Institutional Reforms by State Governments No. of States out of 28 Fiscal Responsibility Legislation (FRL) enacted New Pension Scheme (NPS) introduced Ceilings on Imposed Guarantee Consolidated Sinking Fund (CSF) Guarantee Redemption Fund (GRF) 26 19 17 19 10
Debt Consolidation & Relief Facility (DCRF) of TFC Two-pronged approach A: General scheme of debt relief Applicable from the year of enactment of FRL. Consolidation of all central loans, granted by Ministry of Finance, contracted by States till 31.3.2004 and outstanding on 31.3.2005 Fresh term of 20 years At lower interest rate of 7.5% p.a.
Debt Consolidation & Relief Facility (DCRF) of TFC (cont.) B: Debt write-off scheme, post consolidation of central loans) linked to fiscal performance subject to following conditions s.t. Enactment of FRL Reduction of Revenue Deficit/maintenance of Revenue Surplus, every year starting from 2004-05, when compared to the average of preceding 3 years (i.e., 2001-02. 2002-03 & 2003-04), which forms the base year 2003-04 Reduction in Revenue Deficit should be equal to the at least the interest rate relief on account of consolidation, and Containing Fiscal Deficit at the 2004-05 level in succeeding years.
Major Indicators(%) Year Interest/Total Revenue Receipts Weighted Average Yield of State Govt. 1999-00 22.21 11.89 2000-01 22.16 10.99 2001-02 24.81 9.20 2002-03 25.55 7.49 2003-04 26.39 6.13 2004-05 23.98 6.45 2005-06 19.66 7.63 2006-07 17.73 8.10 2007-08 RE 16.33 8.39 * 2008-09 BE 15.11 * upto Nov07
Part C Issues in Debt Sustainability
Conditions for Debt Sustainability In terms of stable debt-gsdp ratio and rate of growth of nominal GSDP and rate of interest on debt stock are equal- Primary surplus In case of primary deficit, for debt stabilization rate of growth of nominal GSDP is greater than nominal rate of interest. Primary balance of many States, and consequently at aggregate level, continues to be in deficit.
A large hump of repayments of debt due during 2012-13 to 2015-16 due high borrowings during 2002-03 to 2004-05. Leading to large amount of borrowings and pressure on interest rate. Off-budget borrowings through SPVs Guarantees /contingent liabilities
Concluding Remarks States in aggregate on path of fiscal correction, meeting FRBM targets Improvements due to tax buoyancy, higher devolution from Centre, expenditure managements Consolidation of fiscal correction, and consequently sustainability of debt, will come from efficiency gains in expenditure
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