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Debt wish

P Vaidyanathan Iyer

Finance Minister Jaswant Singh has promised a financial package for debt-ridden states by September end. The empowered committee of state finance ministers, which met in New Delhi a fortnight ago, asked Singh to allow them to retire their high-cost borrowings.

In the meeting of the empowered committee on August 8, which Singh heads, three issues were discussed: the impact of the Fifth Pay Commission on state finances and what states can do about it, the states' debt burden and ways to reduce it and how to improve state tax collections.

But even if it comes through, the new package will not serve any purpose if it is not linked to tax and expenditure reforms by the states. North Block has tried twice to entice the states to enter into memorandums of understanding with the Centre and make them commit to wide-ranging reforms but to little effect.

It typically used a "carrot and stick approach" by linking release of money from a Rs 10,600-crore (Rs 106-billion> incentive fund to progress in reforms. But only half the states signed on, and those that did often did not inform the Centre when they raised money from the market through special purpose vehicles.

Presumably the new financial package will come with riders, which can only be for the states' good in the long run. The gross fiscal deficit in absolute terms for 2000-01 stood at Rs 94,821 crore (Rs 948.21 billion), up 4.5 per cent over 1999-2000. The total debt of all states, including central loans, market borrowings, loans from banks, provident funds, is well over Rs 4,00,000 crore (Rs 4,000 billion). Central loans alone make up half of their total debt.

Some of the states have asked to replace their high-cost debt at 14 to 16 per cent with fresh borrowings at 8 per cent. North Block officials say such an exercise would not come without its own cost to the Centre. Faced with the worst-ever drought in over a decade, the states' demands have assumed political significance too.

The states' earlier borrowings do not come with a call or a put option which would have enabled them to exercise their right to buy back the debt. So, technically they cannot do it. However, if the RBI, which is the fund raiser and manager for the Centre and the states, asks the primary dealers and banks to buy back the debt, they would do so - but not without extracting their own pound of flesh, say officials.

For one, the subscribers would demand a premium for selling their old debt since they carry a higher coupon rate. Further, if the states are allowed to borrow from the market to retire their old debt, it could have an impact on the present soft interest rate regime as well as liquidity in the market.

Officials said central loans to the states in the early and mid-1990s, too, carried an interest rate of 13 to 14 per cent. This is what the states are targeting. The states expect the Centre to partially take the hit on its own books by agreeing to replace part of the central loans by providing fresh loans at lower rates.

While this would increase the Centre's capital receipts in the current financial year or the next, the Centre would have to bear the cost of foregoing the higher coupon on its earlier loans.

And that hit, officials say, could be substantial. All this would be worth it only if the states agreed to manage their finances more prudently from tomorrow. Or yesterday, as officials would put it.

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