A Macro view of the fiscal health of States

What in NEWS

In India, States mobilize altogether more than a third of total revenue, spend 60% of combined government expenditure, and have a share in government borrowing that is around 40%.  In order to draw evidence-­based inferences on the fiscal situation of the country —Fiscal imbalance and consolidation, it is necessary to study the States’ budget too.

Concepts

Budget: Article 112 of the Constitution requires the President of India to cause the annual financial statement (i.e. the budget) to be laid before the Parliament on the last day of February or the first working day thereafter

Fiscal Deficit: The budget also includes an estimate of the fiscal deficit, which is the difference between the government’s total expenditure and its total revenue. The government aims to reduce the fiscal deficit to maintain financial stability.

Revenue Deficit: Revenue deficit is that which occurs when the government’s total revenue expenditure exceeds its total revenue receipts. This includes those transactions that have a direct impact on the government’s current income and expenditure and happens when the actual amount of revenue and/or the actual amount of spending do not correspond with the budgeted revenue and expenditure.

Finance Commission: The Finance Commission of India is a constitutional body established by the President of India under Article 280 of the Indian Constitution to define the financial relations between the central government and the individual state governments.

Trends in Fiscal Deficit

• A significant post-­pandemic fiscal correction can be seen at the Union and State levels.
• At the Union level, the fiscal deficit declined from 9.1% of GDP in 2020­-21 to 5.9% in 2023-­24 (Budget Estimate).
• All State fiscal deficit was 4.1% of GDP in 2020-­21. It declined to 3.24% of GDP in 2022­23 (Revised Estimate).
• For the major States, for the year 2023­-24 (BE), it is expected to be 2.9% of GDP.

Data Collection strategy

• After collecting data from individual Budgets of 17 major States, the study has been performed.
• These States are responsible for more than 90% of the combined spending of all States. Thus, fiscal issues emerging out of their Budgets are representative of the State finances in India.

Limitations of Data Collection

• The absence of aggregation of individual State Budget data, a consolidated view of general government finances is not readily available.
• Every year, this data become available only after the publication of the Reserve Bank of India’s (RBI) Annual Study on State Finances, which become available in second-half of the fiscal year.

Analysis of States Budget

The analysis shows that these States together have managed to contain their fiscal deficits. Following are some of the findings from analysis of States’ finances.

1. States have become fiscally prudent after the revenue contraction during peak COVID-19.
2. Emergency provision of health spending during COVID-19 required Union­-State fiscal coordination.
3. To contain Fiscal deficit, States were able to re-prioritize their expenditure.
4.  The reduction in fiscal deficit is a combination of expenditure ­side adjustments, improved Goods and Services Tax (GST) collection and higher tax devolution due to buoyant central revenues.
5.  Non­-GST revenues are also showing signs of recovery after the pandemic in most States.

Fiscal Challenges with States

1. To contain the revenue deficit i.e. the reduction in fiscal deficit has not been accompanied by a corresponding reduction in revenue deficit.
2. In 2023­-24 (BE), out of 17 major States, 13 States have deficit in the revenue account.
3. Out of 13 States, fiscal deficits in seven States are primarily driven by revenue deficits; the States being Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal. They also have large debt to GSDP ratios.
4. For these seven States, their specific shares of revenue deficit in fiscal deficit for 2023­24 are: Andhra Pradesh (40.9%), Haryana (50.9%), Kerala (60.4%), Punjab (70.7%), Rajasthan (39.7%), Tamil Nadu (40.8%), and West Bengal (47%). The all­ State share of revenue deficit in fiscal deficit for the same year is expected to be 27%.
5. An assessment of successive Finance Commissions since the Twelfth Finance Commission identified three States, i.e., Kerala, Punjab and West Bengal, as fiscally stressed States. The number of States that are now fiscally stressed has increased to seven (measured in terms of the level of revenue deficit).

What does it mean for general government macroeconomic stability? 

• The combined fiscal deficit of these States is 3.71% of GSDP when the all-­State average for the same is 2.9%
• Their combined revenue deficit is 2.15 % of GSDP, when the all­-State revenue deficit is 0.78%;
• Their combined debt ratio is higher than the Finance Commission recommended debt ratio for all States for the year 2023-24. These States together contribute around 40% to India’s GDP.

Why Fiscal Stability of States matter?

• To ensure higher State­s specific growth
• Some of these States have also been big drivers of public capital expenditures
• Some States are favoured investment destinations of private investors.

After examining the data from the last 20 years, revenue deficit had almost disappeared from State Budgets before COVID­19. However, the re-­emergence of revenue deficit in recent years should take the focus back on the management of revenue deficit by creating an incentive compatible framework.

The following measures can be considered.

• Interest­-free loans to the States by the Union Government may be linked to a reduction in revenue deficit. This will help eliminate the possibility of a substitution of States’ own capital spending and also prevent the diversion of borrowed resources to finance revenue expenditure.
• A defined time path for revenue deficit reduction with a credible fiscal adjustment plan would help restore fiscal balance and improve quality of expenditure.
• A forward looking performance incentive grants could also be considered for a reduction of revenue deficit. In this context, different approaches provided by earlier Finance Commissions can be considered to decide the framework of the incentive structure.

Conclusion

A macro view is essential for management of States’ finances. The coordination between Centre and State along with recommendations of Finance Commission can led to Fiscal Prudence.