Economy: State budgets: Walking the tight rope - Kotak

State budgets: Walking the tight rope. Aggregate states' GFD/GDP at 2.6% in FY2018 indicates consolidation from the FY2017RE levels. But we are cautious on states achieving this as few states seem poised for some slippages. Further, GST implementation could have its own set of challenges on the revenue front. Though most of the UDAY-related expenditure has been realized through FY2016-17, states could see the pressure remaining from servicing cost. The states' capex has been focused on irrigation and roads with few states also looking at agriculture and energy.

Fiscal consolidation: Optimistic on paper; cautious in reality

Our analysis of 16 state budgets covering 90% of GDP and states' expenditure indicates that aggregate states' GFD/GDP is likely to be around 2.6% in FY2018BE. Excluding fiscally prudent states such as Gujarat and Maharashtra, the GFD/GDP would likely be around 3%. This is down from around 3.4% in FY2017RE, which saw most states factor in UDAY-related expenditure. We are cautious on certain states such as West Bengal (GFD/GDP at 1.8%) and Tamil Nadu (2.8%), which could potentially have slippages in expenditure in FY2018. We note that in FY2017RE almost all states (within our sample) missed their budgeted tax revenues possibly owing to economic slowdown (likely demonetization related). We expect state GFD/GDP in FY2018E at 3.1% after factoring in slippages from 7CPC, potential lower excise collections from alcohol, UDAY servicing, and election-related spending.

Market borrowings: Likely to be higher than last year

After a sharp slippage in FY2017, states' optimistic assumption of lower GFD/GDP seems unconvincing. Given the impending spending and revenue pressures, we expect states' net market borrowings to be higher by Rs500-600 bn at Rs3.8 tn from budgeted borrowings in FY2018 and Rs3.4 tn in FY2017. We expect gross market borrowings at Rs4.5 tn (Rs3.8 tn in FY2017). Despite stressed state finances, consolidated GFD/GDP is likely to slide to 6.3% in FY2018E from 6.9% in FY2017 led by center's fiscal discipline. Consolidated net market borrowings are likely at Rs7.9 tn in FY2018E against Rs7.4 tn in FY2017.

UDAY and 7CPC: UDAY expenses mostly complete; 7CPC ongoing

Much of the higher-than-budgeted expenditure in FY2017 came on the back of UDAY-related expenditure as most states have taken over the debt of the state discoms over FY2016 and FY2017 (and some will continue into FY2018). The amount taken over has been availed to the discoms in the form of capex and grants, which inflated the expenditure. Additionally, in FY2018, states are mandated to account for 5% of discoms' losses in FY2017. Budget speeches and media reports indicate that out of the 16 states under analysis, seven states have implemented the 7CPC recommendations (subject to states' fitment committees).

States' capex: Mostly in irrigation and transport

The states' capital expenditure typically is ~1.5X that of the central government's. The states are due to spend mostly on education, energy, health, irrigation and transport (roads and bridges). There has been some pick-up in urban development too in few states. Based on our sample of states, capex growth in FY2018 is budgeted at (-)0.5%, much lower than 15% growth in FY2017RE. States such as Bihar, Gujarat, Karnataka, Madhya Pradesh, Odisha and Telengana allocate a much higher proportion of expenditure towards capex than the average while states such as Kerala, Tamil Nadu and West Bengal lag behind significantly.

Source : Equity Bulls

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