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Redemption Fund (GRF), which is maintained by the RBI. As of June 2018, only 15 of 29 states had invested in the fund. Among those that had invested, the buffers accounted for 16.4 percent of guarantees outstanding (figure 4.9, panel b). States can also buffer for the repayment of liabilities by paying into the Consolidated Sinking Fund (CSF), also maintained by RBI. Contributions to the CSF are higher than those to the GRF and stood at an aggregate of Rs 1,025 billion at the end of June 2018, equivalent to 0.71 percent of GDP. Contributions to the GRF are earmarked to cover payments from the invocation of guarantees, whereas the CSF aims at covering liabilities from market-based borrowing. Investments in both funds can act as collateral to avail of a Special Drawing Facility at the RBI at favorable borrowing rates, which acts as an incentive to invest in the funds.

Indian states face multiple sources of contingent liabilities. A central question is how the triggering of such potential liabilities affects the local economy, both directly and through adjustments made by state governments. To address this question, we performed an economic analysis to quantify the impact of historic contingent liability realization at the subnational level on the real economy, provide evidence on how state and provincial governments adjust to them, and identify mitigating factors.

Data and Methodology

To study contingent liabilities at the subnational level, we constructed a panel data set of Indian states covering a total of 29 states from 1991 to 2018. The primary data source for this investigation was the Reserve Bank of India’s State Finances data set (RBI 2015, 2019b). We complemented this data with various other sources: information on budgeted expenditure (by line item), adoption of fiscal rules, and fiscal transparency measures were obtained directly from states’ finance departments websites and were hard coded into a comprehensive data set. Detailed information on fiscal transfers by type was obtained from the Finance Commission reports. Data on states’ GDP and gross fixed capital formation was taken from the Reserve Bank of India’s “Handbook of Statistics on the Indian Economy” (RBI 2015).

The analysis of subnational debt developments begins with a decomposition of unexpected shocks into those occurring to the budget (“above the line”) and those occurring through the SFA (“below the line”) (see annex 4A, on methodology). Budgetary (above-theline) shocks are defined as deviations in the realized fiscal deficit from the budgeted fiscal deficit. In contrast, the SFA (below-the-line) shock captures all changes in the debt stock that are not explained by the fiscal deficit. A positive SFA can arise for two reasons: first, because of below-the-line acquisitions of liabilities and assets (such as due to triggered contingent liabilities); and second, because of changes to the valuation of the existing debt stock. Changing valuations can arise, for instance, because of movements in the exchange rate if debt is denominated in a foreign currency or because of changes to interest rates. While not modeled here explicitly, statistical discrepancies can also be responsible for changes to the SFA.

Figure 4.10 highlights the distribution of the budgetary and SFA shocks through box

FiGURE 4.10 Distribution of Above-the-Line and Below-the-Line Shocks to Subnational Debt, india

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Shock value, percent of GDP 2

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Above-the-line shocks Below-the-line shocks

Source: Blum and Yoong 2020. Note: The figure excludes outside values.