While the Centre’s fiscal consolidation path is expected to continue in FY25, Indian states’ fiscal consolidation path post-Covid appears to be on hiatus, says Emkay Global Financial Services Ltd (EGFSL)

“Some risks are emerging in the path of convergence of fiscal consolidation of the Center and the states. The fiscal situation of the states is likely to worsen further in FY25.”

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“Populist spending by states during elections is unprecedented and increases the risk of fiscal slippage in FY25. This could also lead to increased borrowing by states,” said Madhavi Arora, chief economist at the EGFSL.

The fiscal behavior of the center and states differed in the manner in which they achieved consolidation post-Covid, according to the EGFSL analysis.

“The Center exceeded its revenue targets, allowing it to remain focused on investments (capital expenditures) while reducing deficits. In contrast, states have consistently missed their revenue targets, forcing them to sharply cut spending, especially capital spending, even though their revenue growth (revenue spending) has been higher than that of the Center .

“The fiscal consolidation process of Indian states post-Covid appears to be stalled in FY25. While the Center has budgeted a 0.7% reduction in FD (fiscal deficit)/GDP for FY25, states are projecting a 0.2% higher deficit, after reaching an equally higher deficit in FY24P,” according to the analysis.

Elections: gift programs

EGFSL noted that the last two years have seen a shift in fiscal behavior around elections, with this shift being much more evident at the state level.

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Of the top 10 states heading to the polls in 2023 and 2024, almost all have introduced new giveaway programs, regardless of partisan lines, he adds.

This is not a completely new phenomenon: Emkay Global’s analysis of 19 states over the past 20 years shows that, on average, states’ budget deficit/GSDP is 0.5% higher in election years than the previous year, with income/GSDP being 0.4%. percent more, while capex/GSDP decreased by 0.1 percent.

“The worst offenders were Chhattisgarh, Maharashtra, Bihar, Madhya Pradesh, Odisha, Jharkhand and Andhra Pradesh – all states that have had or will have elections by the end of 2025,” said the EGFSL.

State grants for FY25BE soared to ₹3.7 lakh crore following the wave of freebies – this equates to 8.6 per cent/8.7 per cent of overall revenue/expenditure (the highest since fiscal year 21).

Grants are expected to grow 26 percent from the previous year – although there is a base effect, gift announcements have driven this increase.

Arora said, “We believe that states will have to look at innovative ways to better mobilize their revenue to improve their revenue profile so that they can spend without burdening their balance sheet. The sliding deficit will also lead states to borrow heavily in the second half of FY25 (particularly the fourth quarter), particularly for states that are already facing fiscal pressures due to slowing populist and of income growth (Maharashtra, Himachal Pradesh, etc.).

However, overall demand for sovereign debt will remain comfortable in FY25E despite almost stable supply, due to continued demand from long-term players like insurance, pensions and pension funds, as well as of robust FPI flows.