Interest-Free Long-Term Loans for Empowering Development in India

Interest-free long-term loans for capex to the Subnational Governments of India, under the Special Assistance to States for Capital Investment (SASCI) Scheme, would facilitate the effective implementation of the present developmental schemes and infrastructure projects across all the States in unison, thereby empowering development. The Central Government of India’s expedited release of capex loans to states is accelerating development spending and contributing to an increase in overall public capex. Consequently, this boost in public capex is also crowding in private capex. Given the reduction in GST compensation grants and borrowing limits, it would be more advantageous for the State Governments to fully utilize the additional borrowing as interest-free loans for capital expenditures.

Introduction

Interest-Free Loans for Empowering Development

The practice of providing interest-free loans to emerging economies or low-income countries by the developed economies and International Financial Institutions (IFIs) to strengthen their efforts towards inclusive and sustainable development has long prevailed. The International Monetary Fund (IMF) provides loans to its member countries at concessional and non-concessional interest rates for stabilizing their economies, correcting the balance of payments disequilibrium, and restoring sustainable economic growth. Also, during the COVID-19 pandemic, the IMF provided emergency loans at zero percent interest rates as part of its efforts to help countries deal with the economic fallout of the pandemic (IMF, 2021).

Besides that, many countries have provided interest-free loans for capital expenditure, especially to support sustainable development projects and poverty eradication initiatives. For instance, middle east countries like Saudi Arabia, Qatar, and Kuwait have provided interest-free loans to many countries, especially in Africa and Asia, for projects related to infrastructure, education, health, and agriculture (Qatar Fund for Development, 2021) (Saudi Fund for Development, 2021) (Kuwait Fund for Urban Development, 2021). Also, the United Arab Emirates provides development financing to support sustainable economic growth in developing countries. The Abu Dhabi Fund for Development (ADFD) has provided interest-free loans to many developing countries around the world, including countries in Africa, Asia, and Latin America. These loans have supported a wide range of projects, including building hospitals, schools, and water treatment plants, as well as developing renewable energy sources such as solar and wind power.

Interest-free loans, particularly as a form of external assistance, can help emerging and developing economies recover from the economic crisis and promote sustainable development initiatives. Likewise, providing interest-free loans for domestic debt can also be an effective tool for promoting economic growth, reducing debt burdens, and increasing capital expenditure. By encouraging investment and making it easier for individuals and businesses to access the financing they need, interest-free loans can help to drive long-term economic prosperity.

Japan introduced interest-free loans for domestic debt in the early 2000s as part of its efforts to address a period of economic stagnation and deflation that had lasted for more than a decade. The policy, known as the “zero-interest rate policy” (ZIRP), was intended to encourage borrowing and stimulate economic activity by reducing the cost of borrowing. By lowering interest rates to zero, the government hoped to encourage businesses to invest and consumers to spend, thereby stimulating demand and boosting economic growth (Syedet al., 2009). The policy was initially successful in stimulating economic activity and boosting inflation, but it also contributed to the creation of a housing bubble and subsequent financial crisis in 2008. In the years following the crisis, the Bank of Japan continued to implement ZIRP and later introduced a policy of negative interest rates in 2016 as part of its ongoing efforts to stimulate economic growth and combat deflation (Yoshinoet al., 2017).

Interest-Free Loans to Subnational Governments of India

Maintaining fiscal consolidation with growing capital investment requirements is somewhat paradoxical in the current competitive environment for growth and development in emerging economies. However, both are necessary for achieving sustainable long-run economic growth. In the wake of the COVID-19 pandemic and sluggish nominal gross domestic product (GDP) growth, national and subnational governments of India had deviated from the fiscal consolidation path, such as when the Union and State Governments’ gross fiscal deficit increased to an all-time high of 13.1% of the nominal GDP in 2020–2021 and the public debt reached 89.6% of GDP in the same year, which was a way beyond the sustainable ceiling set by the Fiscal Responsibility and Budget Management (FRBM) Act. The FRBM Review Committee (2017, p. 135) has recommended that the general level of public debt be 60% for the Central and State governments combined, constituting 20% for State governments and 40% for Central governments.

A large-scale fiscal stimulus unleashed by the Central and State governments to fortify safety nets during the pandemic period, notwithstanding lower revenues, has had an adverse effect on fiscal prudence, which led to an unparalleled spike in the gross fiscal deficit and in the level of public debt. Thereafter, to maintain the quality of fiscal consolidation, the Government of India has envisioned a medium-term fiscal consolidation plan for the subnational governments with increased borrowing limits above the sustainable threshold limit of 3% of their gross state domestic product (GSDP) set by the Fiscal Responsibility Legislation (FRL), to support developmental expenditures in the states. However, it is important to ensure that this additional borrowing is used in a responsible manner and is targeted towards productive and sustainable investment that supports long-term economic growth. It is also crucial to monitor the impact of this borrowing on subnational government debt levels and ensure that it does not lead to unsustainable debt burdens in the future. Overall, the success of this approach will depend on how it is implemented and monitored over time to ensure that it achieves its intended goals without compromising fiscal sustainability and quality.

In the same way, the government of India introduced a “Scheme for Special Assistance to States for Capital Expenditure (SASCE)” in the financial year 2020–2021, which was extended further for the year 2021–2022, under which a conditional 50-year interest-free long-term loan to state governments have been provided to undertake specific reforms or initiatives and capital investments. Special assistance to states in the form of a 50-year interest-free long-term loan has incentivized states to complete the four citizen-centric reforms, viz., One Nation One Ration Card, Ease of Doing Business, Urban Local Bodies Reforms, and Power Sector Reforms, within FY21 itself and privatization/disinvestments of the State Public Sector Enterprises (SPSEs) and monetization/recycling of assets in FY22.

To give strong impetus to State capex plans, the SASCE scheme has been reintroduced as “Special Assistance to States for Capital Investment (SASCI)” for the financial year 2022–2023. This scheme has seven components in total, which include an unconditional component and smaller components linked to specific reforms or initiatives (Table II). The Government of India has further extended the fifty-year interest-free loan scheme for one more year, 2023–2024, with the aim of boosting the states’ capital expenditure in FY24. The interest-free long-term loans in the financial year 2023–2024, intended only to boost capex in the states, which means that state governments cannot utilize these funds for revenue expenditure. The greater part of the allocated amount is at the discretion of states; however, a portion of the total allocation is conditional on states raising their real capex.

Budgetary Provision for the Scheme for SASCE/SASCI

Investing in capital expenditure has a significant positive impact on the economy as it results in a multiplier effect that boosts overall economic activity. This, in turn, leads to an increase in future productive capacity, driving sustainable economic growth. With this mindset, the Central Government has provided financial support to states for capital expenditure through the scheme of interest-free long-term loans.

In Table I, the budgetary provision for the 50-year interest-free loan scheme for the last three years and the current financial year is mentioned. The Central Government has been increasing the allocation under the SASCI scheme for each financial year since the very first implementation year, such as when it was ₹12,000 crore in FY 2020–2021, then increased by 25% to ₹15,000 crore in FY 2021–2022, and after that, it was increased by seven times in FY 2022–2023. The Central Government has allocated a substantial amount of ₹1.30 lakh crore towards the SASCI scheme for the current financial year 2023–2024, which is 23.8% higher than that for the financial year 2022–2023. A capex assistance amounting to ₹95147.20 crore has been approved, and ₹81195.35 crore has been released to States for the financial year 2022–2023 under the SASCI scheme by the Central Government.

Table I. Fund Allocation for the SASCE/SASCI Scheme

Financial year	Budget allocation (₹ crore)	Approved amount (₹ crore)	Released amount (₹ crore)
2020–2021	12,000.0	11911.79	11830.29
2021–2022	15,000	15927.67	14186.0
2022–2023	1,05,000	95147.20	81195.35
2023–2024	1,30,000	–	–

Table II. Budgetary Allocation for Components of SASCI 2022–2023 Scheme

Component	Basis	Allocated (₹ crore)
I	Allocation proportional to the share of tax devolution for FY23	80,000
II	PM gati shakti-related expenditure	5,000
III	PM gram sadak yojana (PMGSY)	4,000
IV	Incentive for digitisation	2,000
V	Optical fibre cable	3,000
VI	Urban reforms	6,000
VII	Disinvestment and monetisation	5,000

Component-Wise Allocation

In Table II, component-wise budget allocation for the SASCI scheme 2022–2023 is represented. A total allocation of ₹80,000 crore has been earmarked for the Part-I component, which relates to unconditional additional borrowing by state governments for capex based on their share of tax devolution for FY23. A budgetary provision of ₹5,000 crore was made for the Part-II component, which belongs to expenditure related to the Pradhan Mantri Gati Shakti Programme. Also, ₹4,000 crore has been earmarked for the Pradhan Mantri Gram Sadak Yojana (PMGSY) under the Part III component of the SASCI 2022–2023 scheme. The other components of the SASCI 2022–2023 scheme relate to specific reforms such as Part IV, which includes the Incentive for Digitization, Part V for Optical Fibre Cable, Part VI for urban reforms, and Part VII for incentives to State Governments for privatization or disinvestment of the State Public Sector Enterprises (SPSEs). For these prescribed reform-based components, a total amount of ₹16,000 crore has been allocated by the Centre, from which ₹15,383.85 crore has been released to State Governments in the financial year 2022–2023.

State-Wise Allocation

A state-wise allocation under the Part I component of the SASCI 2022–2023 scheme is given in Fig. 1. The budgetary allocation to State Governments under the Part I component of the scheme was based on their share of tax devolution. Thus, the highest share of 17.9%, amounting to ₹14,351 crore, has been allocated to the state of Uttar Pradesh, followed by a 10% share for Bihar, a 7.85% share for Madhya Pradesh, a 7.5% share for West Bengal and like so for rest of the State Governments.

Fig. 1. State-wise budget allocation under part-I of the SASCI 2022–2023 scheme (in ₹ crore). Source: Ministry of Finance (2023a).

In the current SASCI 2023–2024 scheme, a conditional proportion of the total outlay is linked to major initiatives like scrapping old government vehicles, urban planning reforms and actions, financing reforms in urban local bodies to make them creditworthy for municipal bonds, housing for police personnel above or as part of police stations, constructing Unity Malls, children and adolescents’ libraries and digital infrastructure, and State share of capital expenditure of central schemes.

Thus, when this type of interest-free long-term loan is provided for capex under specific heads of development, it facilitates boosting growth momentum in unison from all the states simultaneously.

Subnational Governments’ Capex and Outstanding Liabilities

Fig. 2 shows the trend of Subnational Governments’ total capital expenditure during the previous five years in India. It is evident that State Governments considerably boosted their capex in the fiscal years 2021–2022 and 2022–2023. The States’ total capital expenditure shows an 11.37% compound annual growth rate (CAGR) during the five-year period of 2018–2019 to 2022–2023. It is evident that the total capex of State Governments has increased at a CAGR of 22.1% since the implementation of the SASCE (2020–2021) scheme. It is also noteworthy that the capital outlay-to-GDP ratio of Subnational Governments has also shown a significant improvement in the last two financial years, such as it has increased by 0.8% to 2.8% of GDP from 2020–2021 to 2022–2023.

Fig. 2. Total capital outlay and capital outlay as the percentage of GDP (at current market prices) of subnational governments. Source: RBI (2023).

However, it is worth mentioning that the capex of subnational governments did not increase in a sustainable fiscal atmosphere but with the simultaneous increase in the public debt-to-GDP ratio in the post-COVID-19 pandemic period. It is evident from Table III that the public debt of subnational governments increased to 31.1% of GDP during the pandemic period 2020–2021, and thereafter, it declined but remained way above the sustainable level of 20% of GDP recommended by the FRBM Review Committee (2017, p. 135).

Table III. Outstanding Liabilities of State Governments and Union Territories

Financial year	Amount (₹ lakh crore)	Annual growth (%)	Debt/GDP (%)	Loans and advances from the centre (% of total outstanding liabilities)
2018–2019	47.87	11.5	25.3	3.6
2019–2020	53.51	11.8	26.7	3.0
2020–2021	61.55	15.0	31.1	5.1
2021–2022 (RE)	67.94	10.4	28.7	6.7
2022–2023 (BE)	76.10	12.0	29.5	6.9

The interest-free loans provided by the Centre to State Governments under the SASCE/SASCI scheme have contributed to increasing the proportion of loans and advances from the centre in total outstanding liabilities, which was only 3.0% in FY 2020 and, after that, increased to 5.1% in FY 2021 and subsequently to 6.7% and 6.9% in the financial years 2021–2022 and 2022–2023, respectively.

Creating fiscal space to sustain capital expenditures while maintaining fiscal consolidation is a critical priority for State Governments. It requires a careful balance between managing public debt and financing the necessary investments to support economic growth and development. To achieve this balance, State Governments must prioritize investments that have high economic returns and long-term benefits for the economy. They must also focus on improving operational efficiency, exploring alternative financing models such as public-private partnerships, and identifying opportunities to generate additional revenue.

Plausible Implications of Interest-Free Loans for Subnational Governments of India

The provision of interest-free long-term loans to subnational governments as special assistance for capex under different schemes and initiatives of development would accelerate growth momentum simultaneously across all states, which strengthens the multiplier effect, so the overall growth and development of the country. The SASCI scheme incentivizes states to undertake infrastructure development projects on a priority basis by providing more room for the ambitious “Pradhan Mantri Gati Shakti” plan. The PM Gati Shakti is an integrated national master plan that brings various ministries, including Railways and Roadways, together for the holistic planning of infrastructure connectivity projects. PM Gati Shakti enabled the synchronization between the Centre and State governments in planning and executing the projects. In this way, interest-free funds for capex under the PM Gati Shakti would help in strengthening the cooperative federalism that is required to promote the overall development and welfare of the country.

As infrastructure investments have a high spill-over impact on long-term economic growth, the Centre’s interest-free loans to State Governments for specific infrastructure development projects under PM Gati Shakti and for other projects of economic reforms would be helpful in managing the fiscal prudence and sustainable level of debt. The SASCI 2022–2023 scheme has also provided incentives to State Governments for disinvestment or privatisation of underutilised SPSEs, which generate additional revenue for financing the capex.

The sustainability of public debt should be the foremost concern for national and subnational governments in India, given the increasing dependence on public borrowing for deficit financing. When it comes to fiscal consolidation, the easiest option is to curtail capital spending, as a reduction in revenue expenditure will not be trouble-free. As the enhancement of capex is a prerequisite condition for sustainable economic growth and development, the provision of interest-free loans for capex would help the subnational governments maintain fiscal consolidation without restraining capex plans. However, for the ongoing financial year, the states’ utilization capacity for these interest-free funds is critical for realising the warranted capital investments given the scheduled reduction in the additional borrowing limit as well as a drop in the GST compensation grants.

Moreover, interest-free loans for a long maturity period of 50 years would reduce the rollover risk and would help the state governments mitigate the debt servicing cost in the form of interest payments. Investments related to infrastructure development usually have a long gestation period. Thus, an interest-free capex loan for such a longer maturity period would be self-liquidating, which means it will reduce the debt redemption burden on the state governments in the future.

Conclusion

Interest-free loans as a means of financing for both domestic and external debt can be beneficial in many ways. Interest-free loans can ultimately lead to reduced debt burdens and more manageable repayments. It is evident from the experiences of many countries that interest-free loans can stimulate economic growth by providing funding for critical infrastructure projects and other key areas of development.

In the case of India, the initiative of providing interest-free long-term loans of a 50-year-long maturity period for capex to Subnational Governments would be promising to boost the economic growth of India, as it would facilitate the effective implementation of the present developmental schemes and projects across all the States in unison. The SASCE/SASCI scheme provided more fiscal space for capex to the Subnational Governments of India at that time when they were concerned about fiscal consolidation. However, the effective utilisation of these interest-free funds is crucial to attaining the intended goals of the SASCI scheme. State Governments have faced a reduction in their borrowing limits from 4% in 2021–2022 to 3% of Gross State Domestic Product (GSDP) in 2023–2024 and a decrease in GST compensation grants. Therefore, it would be more advantageous for them to fully utilize the additional borrowing as interest-free loans for capital expenditures.

Overall, while the SASCI scheme can provide a boost to the economic development of the States and help promote cooperative federalism, its success will depend on effective implementation and monitoring, as well as the ability of the States to undertake capital investments that generate adequate returns and revenues.