Deteriorating state government finances pose a risk to India, which already boasts the second-largest budget deficit among major economies, Oxford Economics said in a note.
India has signalled a larger fiscal deficit for the federal government for the year to March 2018 and while it has forecast a lower gap for next year, with the general elections due in early 2019 many expect that target to be breached. Compounding those concerns are higher state government deficits, lower-than-expected revenues from the newly introduced goods and services tax, and farm loan waivers.
“This could eventually raise concerns about debt sustainability, leading investors to demand even more premium over central government securities to subscribe to state development bonds,” said Priyanka Kishore, lead Asia economist at Oxford Economics, Singapore.
Indeed, in the past few weeks, the spread between the 10-year benchmark federal bond and the average cut-off yield on state government bonds at auction has widened to more than 60 basis points from around 55 bps in the middle of February.
Kishore said states are aiming to narrow their deficits to 2.7% of GDP in the year to March 2018, but that is unlikely to happen.
“This appears ambitious, especially given the farm debt waivers announced in several states post the FY18 budget,” Kishore wrote in the note. “Instead, we expect the all-state deficit to remain just above 3% in FY18.”