India's States Are Drowning in Debt

As New Delhi cuts subsidies, they're on their own

In the rough-and-tumble of India's local politics, no tradition is better honored than the electoral giveaway. Over the years, profligate incumbent politicians in the provinces have handed out tens of billions of dollars' worth of subsidies to attract the votes that keep them in power. Water, power, land, food, and other necessities have all been doled out by past and present state governments at little cost to the voting public. The result has been yawning budget deficits. But no matter--the national government in New Delhi, eager to earn the fealty of state satraps, has happily made up the difference.

Now, the spigot is finally running dry. Groaning under $122 billion in debt and budget deficits that in some cases rise to almost 10% of states' gross domestic product, the governments are being forced to bite the fiscal bullet by slashing subsidies and selling off money-losing state-owned industries. One reason: The national government, burdened by its own fiscal and debt crisis, is in no condition to bail them out. "For the first time, the states have to deal with their own financial demons themselves," says Subir Gokarn, chief economist of CRISIL, India's top rating agency.

A few statistics tell the story. The country's total federal and state budget deficit will equal nearly 11% of GDP for the year ending Mar. 31. That's second-highest in the world, after Turkey. CRISIL rates the debt of highly industrialized Maharashtra state as junk grade. Gujarat must also borrow at high rates. In fact, the only states whose debt is considered investment grade are Karnataka, Tamil Nadu, and Andhra Pradesh, home to India's high-tech enclaves.

Last September, Maharashtra defaulted on $500 million in bonds issued to fund irrigation projects in the state. Maharashtra, Bihar, and Uttar Pradesh have on several occasions in the past four years postponed salary and pension payments for civil servants such as teachers and police.

If this continues, says Gokarn, "and the states are unable to deliver on their public service commitments, you could see mass protests and political upheaval."

How did the states get into such a mess? Under India's highly centralized system, money came pouring in from New Delhi with few strings attached and no real expectation of repayment. Then, in 1997, a new law to counter corruption raised the salaries of government employees by 20%--a huge hit for the states, whose bloated bureaucracies already absorbed more than half their budgets. Now, borrowing has taken off as revenue declines in the face of a slowing economy.

Last October, Prime Minister Atal Bihari Vajpayee and Finance Minister Jaswant Singh summoned the chief ministers of India's 28 states to an unprecedented meeting in the capital and demanded that they get their finances in order. As an incentive, Delhi offered to forgive debt in exchange for reforms. Several states are taking up the offer. The states must take action, says New Delhi economist Surjit S. Bhalla, manager of the Oxus Fund. "It can no longer be business and corruption as usual."

Some of the steps are bold. Arminder Singh, the newly elected chief minister of Punjab, one of India's wealthier states, on Nov. 1 stopped giving away free water and power to farmers, which will save the state $220 million per year. Maharashtra, home to India's commercial capital, Bombay, has plans to cut its deficit by privatizing state-owned irrigation systems and reducing its politically sensitive cotton subsidies, which had been draining the state of an estimated $82.5 million a year. Uttar Pradesh plans to sell off a piece of its power sector. Across India, the deficits of state electricity boards alone add up to 5% of GDP.

So far, the models of fiscal probity are modernist states like Karnataka and Andhra Pradesh. Analysts hope they will set good examples. The change in attitude, however, is still fragile. This year, nine states, including the capital district of New Delhi, Madhya Pradesh, and Rajasthan, will elect chief ministers. The worry is that, once again, the politicos will yield to the temptation to buy votes with handouts.

By Manjeet Kripalani in Bombay

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