Lending rate on small savings loans to states linked to FRBM

NEW DELHI: The Union cabinet has cleared a finance ministry proposal to withdraw lower lending rates offered to states on loans from the National Small Savings Fund (NSSF) in case they fail to achieve their FRBM (fiscal responsibility and budget management) targets in a bid to put pressure on them to improve their finances.

The reduced interest rate of 9% will be withdrawn in respect of NSSF loans in case a state deviates from the targets in its FRBM Act and the original interest rate will be restored from the year 2012-13, a statement issued on Thursday said. "This is a clear way to bring in fiscal discipline into the state governments," said Sunil Sinha, senior economist, CRISIL.

The proposal is in line with the recommendations of the thirteenth finance commission.

"The state will be considered eligible for relief measures recommended by the 13th Finance Commission on NSSF loan from the date of FRBM Act is amended/enacted in accordance with the recommendation of the 13th Finance Commission," said the proposal.

States on an average borrow around 6-8% of their gross fiscal deficits from the NSSF.

However, economists believe due to rising market interest rates states will want to maximise their borrowings from small savings fund. "This might lead the states to pose some opposition, as it is already difficult for them to tap open markets and interest rates have been rising," said Sinha.

The proposal maintains that as long as the recommendations of the 13th finance commission are followed, the states will be eligible for relief as per the recommendations of the commission. According to the ministry's proposal, "The 13th Finance Commission has recommended that the interest rate of NSSF loans contracted by the states till 2006-07 and outstanding at the end of 2009-10, be reset at a common interest rate of 9% in place of existing 10.5% or 9.5%."

"This debt relief is recommended to be available to states only if they amend/legislate FRBM Act in accordance with the recommendations of the Commission," the release said. "The initial FRBM targets were calculated assuming certain economic growth rates. However due to the slowdown, it might now be possible for states to meet those targets," said DK Srivastava, professor of Madras School of Economics.