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Prepared by Mark Flanagan.
The initial reduction in the deficit could even be slightly higher once composition effects—the fact that larger states will be receiving more in resources—are accounted for. See Howes and Prasad (2005) for a more detailed analysis of state-by-state impacts.
Lending to states is recorded above the line for the central government (as net lending) but as borrowing—a financing item—for states. Intergovernmental borrowing and lending has no impact on the consolidated general government accounts.
The central government must approve a state’ borrowing if the state owes anything to it.
See Ahmad, Albino-War and Singh (2005). Market discipline is most prevalent in developed economies (e.g., the United States and Canada) with long histories of no bail-outs.
For some states which are in relatively good fiscal shape, the substantially higher-than-market NSSF interest rates represent a significant burden. For other states, they represent a significant subsidy.
See Rajaraman et al. (2005) for an analysis of the need for revenue and expenditure measures by state.
The debt stabilizing primary balance can be calculated as the nominal interest rate minus the nominal growth rate, multiplied by the initial debt ratio, and deflated by the nominal growth rate.
Data were not available to assess special category states, but it should be noted that their average debt ratio in 2004/05 was 13 percent of GDP higher than the average for general category states, suggesting that the problem might be more acute for many of them.
The high growth scenario does not improve the outcome, since interest and growth rates move up in tandem.
The residual adjustment for two of the states declines to under ¼ percent of GDP if they simply maintain their current deficit, rather than loosening to achieve TFC targets.
Another category of state—those which have already achieved the FRL deficit targets—may choose not to participate altogether. This would allow them to raise their overall deficit (and thus capital spending), which would otherwise be capped at present levels.