Unexpected Improvement in State Fiscal Health: Blessing or Curse?

30 Jan 2023

Lower than expected spending and borrowing by state governments have perplexed the bond market in FY 23 and Citi analysts estimate the FY 23 state fiscal deficit at 2.3% of GDP, as opposed to the budgeted estimate of 3.4%.

• 1. A relook at state finances: In the first 8 months of FY 23, the state’s fiscal deficit has reached only 35% of the budgeted target of 3.4% fiscal deficit for FY 23. This is lower than previous trends, when the state deficit reached 51% in the first eight months of the fiscal year. Citi analysts cut the state's fiscal deficit forecast from 2.6% to 2.3% of GDP. Higher-than-expected nominal GDP and tax revenue growth, a shortfall in projected spending, and a general overestimation of the budget estimates prompted the revision.



• 2. Lower bond supply in 4QFY23: For remainder of FY23 SDL issuance is likely to be INR 2 trillion, or INR 800 billion lower than announced, resulting in near term total supply of (G sec + SDL) at comfortable level and softer bond yield. Citi analysts expect 10-year G sec yields to ease to sub 7% in coming months.



• 3. Paring down bond supply expectations: Given the recent trend of undershooting SDL supply, i.e., FY 22 was 24% lower than budgeted and now FY 23 has a projected shortfall, the market may lower its actual bond supply expectation for FY24, despite a likely 37% YOY jump in planned FY24 SDL issuance.
• 4. Supporting growth and capex momentum: States would have to spend INR 5 trillion in Dec-Mar FY23 to meet their capex target, which means spending 2/3 of the full year's budgeted target. Any significant shortfall will have near-term negative growth implications.

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