*The combined stock of debt owed by Indian states is about 21% of GDP, and is proliferating. In this article, Ananya Kotia discusses why the stock of the states’ debt is unsustainable today despite their commendable adherence to hard limits on borrowing flows imposed by India’s fiscal rule framework.*

**Internally inconsistent fiscal rules**

^{th}Finance Commission, the level of the states’ fiscal deficit target was probably kept at 3% to make it politically palatable by maintain equality with the Centre’s deficit target.

**The importance of the level of debt**

_{t}=1/(1+γ) d

_{(t-1)}+f

_{t}

_{t}is the debt-GDP ratio in period t; γ is the nominal growth rate of GDP; f

_{t}is the fiscal deficit to GDP ratio in period t.

*magnitude*of debt, the centre’s debt-GDP

*ratio*decreased from 49.4% in FY17 to 47.4% of GDP in FY18. How? Because between FY17 and FY18, GDP growth eroded as much as 5.5 percentage points from the central government’s debt-GDP ratio.

**Implication for setting fiscal targets**

*because of its larger stock of debt alone*. Symmetry cannot be forced on the targets for fiscal deficits of central and subnational borrowing given the significant difference in their present and desired stocks of debt. Any such attempt will simultaneously induce the debt-GDP ratios of the two tiers of government to converge. Currently, at around 3% of GDP, the states are borrowing more than their annual erosion of debt due to nominal GDP growth. If this trend continues, their debt-GDP ratio will continue to rise, eventually stabilising at around 30% − far above the desired level.

^{1}if they keep their fiscal deficit constant. The figure presents two scenarios: first, the symmetric FRL case and second, the alternative scenario of 2% and 4% deficit ceiling for the states and the centre, respectively (which are consistent with their respective desired levels of debt).

**Figure 1. Debt projections under present fiscal responsibility legislation (FRL) and alternative scenario for the Centre and the states**

^{th}Finance Commission − which is likely to be set up soon − must amend fiscal rules to maintain consistency between stock and flow variables.

*An earlier version of this article appeared in the Business Standard on 7 July 2017.*

*Note:*

- I assume nominal GDP growth of 11.11% (equal to the CAGR (compounded annual growth rate) of the past five years, that is, from 2012-13 (99,440 bn) to 2016-17 budget estimates (168,475 bn). The projections are based only on equation (1) above. The starting values (FY18) of the debt-GDP ratios are 47.4% for the Centre and 21% for the states.