Off-balance-sheet borrowings of states are estimated to have reached a decadal high of ~4.5% of gross state domestic product (GSDP), or ~Rs 7.9 lakh crore, in fiscal 2022. That marks a rise of ~100 basis points from fiscal 2020, reveals a CRISIL Ratings study of 11 states¹ that account for ~75% of the aggregate GSDP.

These borrowings have been raised by entities owned by states, which also guarantee the loans. Around 4-5% of the revenue of states will go towards servicing such guarantee obligations this fiscal, partially reducing the ability of state governments to fund capital expenditure (capex).

The reasons for the rise in off-balance-sheet borrowings are two-fold. One, constrained revenue growth due to the pandemic-induced slowdown and increasing revenue expenditure have led to their fiscal deficits rising to close to 4% of GSDP, well above the historical level of 2-3% seen for most part of the last decade. This has reduced the wherewithal of states to directly fund the entities they own.

Two, even if states wanted to do so by borrowing more, they can’t without the explicit approval of, and beyond the limits set by, the central government. But states don’t need prior central consent to guarantee the loans and advances, and bonds issued by its entities. Also, the ceiling on guarantees is self-determined and varies by state. All these have led to greater reliance on off-balance-sheet borrowings.

Says Anuj Sethi, Senior Director, CRISIL Ratings, “The power sector — primarily discoms — account for almost 40% of the outstanding state guarantees. These were taken to repay the dues of power generation and transmission companies with discoms continuing to make cash losses. With most of them expected to continue reporting losses this fiscal as well, due to higher input (mainly coal) costs, states will have to provide higher support for timely servicing of the guaranteed facilities.”

Other beneficiaries of these guarantees are state-level entities involved in irrigation infrastructure development, drinking water supply, and food and civil supplies. Cumulatively, they are recipients of ~30% of such guarantees. However, as these entities are working to build social infrastructure and funding social welfare schemes of their governments, their own cash flows are limited. Hence, majority of their debt servicing obligations will be eventually funded by states through budgetary allocations.

But not all state-owned entities will require support from their governments for servicing of guaranteed instruments. About 10-15% of the guarantees are also provided to entities involved in urban development and infrastructure set-up, which may have their own cash flows to service the guaranteed facilities.

Says Aditya Jhaver, Director, CRISIL Ratings, “We believe cash-flow support will be required for 50-55% of the outstanding guarantees, and that 4-5% of the annual revenue of states will be consumed for servicing these obligations this fiscal². This is more than double of the mark seen 4-5 years back and hence will partly constrain their flexibility to fund capex in the near future.”

With almost 3x increase in the absolute quantum of these guaranteed borrowings over the last five fiscals, and with state level entities approaching the capital markets as well, fiscal prudence of the states to budget for these guaranteed obligations and allocating funds to the state-level entities in a time-bound manner will be critical.

That said, improvement in states’ cash flows through higher collections of goods and services tax and reduction in losses at discoms through cost-reflective tariffs and enhanced commercial orientation can provide some breathing space to states. These will remain monitorables.

¹ States analysed: Maharashtra, Gujarat, Karnataka, Tamil Nadu, Uttar Pradesh, Telangana, Rajasthan, West Bengal, Madhya Pradesh, Andhra Pradesh and Kerala
² This assumes interest rate of ~9% on average and debt tenure of 7-8 years; revenues assumed as per budget estimates for fiscal 2023