Now, their fiscal deficit targets could be missed by states .

Mumbai: India’s sharp slowdown is endangering the fiscal deficit targets of its states, threatening to unravel progress made over the past few years and driving borrowing costs higher for a few of these.

The states have budgeted a combined fiscal deficit target of 2.6percent of gross domestic product in the financial year ending March, a recent study by the Reserve Bank of India shows. While the deficit ratio has remained within the mandated threshold of 3% of GDP in the past two years, doubts are growing in their ability to fulfill the most recent goal. Any slippage could see India’s general public finances come under pressure and raise the probability of a downgrade by rating firms.

Only last month, Moody’s Investors Service cut the country’s credit rating outlook to negative, citing a litany of issues from a worsening shadow banking crunch and a prolonged slowdown in the market to increasing public debt.

Outstanding debt of nations has risen over the past five years to 25% of GDP, posing medium-term challenges to its sustainability, according to the RBI study.

The yield on 10-year bonds sold by West Bengal, which has among the lowest deficit ratios among India’s 28 states, climbed to 7.29percent in December from 7.06% in July, data compiled by Bloomberg News show. That is still lower than the 8.21% at the start of the year, as yields monitored the RBI’s aggressive interest rate cuts.

Despite attractive yields on nations’ debt that carry an implicit sovereign guarantee, there’s little interest from global funds — that have used only 2.2% of their 612-billion rupee ($8.6 billion) investment limitation available to them in these notes. Part of the reason, according to fund managers, is too little price differentiation between the better-run and poorer countries.

West Bengal is joined by countries such as Gujarat and Maharashtra who have been able to keep their financial deficits at less than 3 percent of GDP. But they all pay a coupon similar to that of, or greater than a few of their peers that are weaker. Require Rajasthan: the western Indian state had an average gross fiscal deficit of 5.4percent between financial years 2016 and 2019, but marketed 10-year bonds this month in a yield of 7.18%.

States have not had a problem attracting local investors with returns that are typically greater than those on notes issued by the national government.

Increasing debt obligations are restricting the scope for increased capital spending by some of those states.

‘With the center’s finances already under acute stress, we may see cut backs at pace of spending of both the centre and states,’ said Garima Kapoor, an economist in Elara Securities India Pvt. in Mumbai. ‘This could have consequences for domestic and expansion liquidity requirements.’

A Moody’s evaluation of state budgets indicates that capital expenditure by states will likely grow only slightly to 5.5 trillion rupees in the current financial year from 5.4 trillion rupees the previous year.

Social sector spending, which recovered from the year ended March 2019, is expected to hold up in the present year, broadly in line with Prime Minister Narendra Modi’s vision of higher welfare reaching the poorer sections of society.

‘A shift is projected from expenditure on education, health and family welfare to sectors like housing and urban development and expenditure on social security and welfare,’ Care Ratings Ltd. wrote in a report, adding that recent initiatives such as a health program for all can influence social sector expenditures.

The growth slowdown also means revenue for states collections.

It will’constrain states’ ability to support their rising debt burdens and address spending needs, especially for states with debt burdens over 200% and debt service over 30 percent of operating revenue, such as Haryana, Punjab, Kerala and West Bengal,’ Moody’s said in a report. – Bloomberg