Assessing States’ Fiscal Health: A Macro View

• Posted on July 5, 2023
• Editorials,GS-3

A macro view of the fiscal health of States

Context:

In India’s fiscal landscape, the States play a pivotal role, mobilizing over a third of total revenue, accounting for 60% of government expenditure, and holding a substantial share in government borrowing. Given their significant fiscal operations, a comprehensive analysis of their finances becomes imperative to draw evidence-based inferences on the country’s overall fiscal situation. In light of this, this analysis delves into the emerging fiscal situation of States, examining key data from individual State budgets for the fiscal year 2023-24.

Relevance:

GS-03 (Fiscal Policy, Planning, Mobilization of resources)

Prelims:

• Fiscal deficit
• GDP
• Subsidies
• Capital spending
• India’s external debt

Mains Questions:

• Critically examine the rising revenue deficit of certain States and its implications for general government macroeconomic stability. Propose a framework to incentivize revenue deficit reduction while fostering fiscal stability. (250 words)

Dimensions of the article:

• Fiscal Imbalance and Consolidation.
• Fiscal Challenges.
• Implications and Framework for Revenue Deficit Consolidation

Fiscal Imbalance and Consolidation:

• As the fiscal year 2023-24 commences, it becomes evident that the pandemic-induced surge in general government deficit and debt is gradually receding. Both the Union and States have undertaken notable fiscal corrections.
• The Union’s fiscal deficit declined from 9.1% of GDP in 2020-21 to 5.9% in 2023-24 (BE), while all State fiscal deficit reduced from 4.1% of GDP in 2020-21 to 3.24% in 2022-23 (RE) and is expected to be 2.9% of GDP for major States in 2023-24 (BE).
• The publication of the Reserve Bank of India’s (RBI) Annual Study on State Finances provides the required data but only during the second half of the fiscal year. Hence, this analysis is based on data collated from the budgets of 17 major States, representing over 90% of combined State spending, providing insights into fiscal consolidation.
• The significant fiscal consolidation achieved by these States is commendable on multiple fronts.
  1. They demonstrated fiscal prudence despite facing a substantial revenue contraction during the pandemic.
  2. Ensuring health and livelihood provisions required effective Union-State fiscal coordination.
  3. These States adeptly reprioritized expenditures, containing the fiscal deficit.
  4. The reduction in fiscal deficit can be attributed to expenditure-side adjustments, improved Goods and Services Tax (GST) collections, and higher tax devolution from buoyant central revenues.
  5. Non-GST revenues are showing signs of recovery post-pandemic in most States.

Fiscal Challenges:

• In the fiscal year 2023-24 (BE), 13 out of 17 major States exhibit deficits in their revenue accounts, with seven states – Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal – experiencing fiscal deficits primarily driven by revenue deficits. These States also grapple with large debt-to-GSDP ratios.
• While the presence of revenue deficits is not inherently indicative of fiscal profligacy, understanding the root causes behind their rise necessitates detailed analysis. Long-term fiscal implications arise from increasing revenue deficits that contribute to fiscal imbalances, demanding corrective measures in the revenue account.
• For the aforementioned seven States, their respective shares of revenue deficit in fiscal deficit for 2023-24 are as follows:
  1. Andhra Pradesh (40.9%)
  2. Haryana (50.9%)
  3. Kerala (60.4%)
  4. Punjab (70.7%)
  5. Rajasthan (39.7%)
  6. Tamil Nadu (40.8%)
  7. West Bengal (47%).
• An assessment of successive Finance Commissions reveals that the number of fiscally stressed States has increased from three (Kerala, Punjab, and West Bengal) during the Twelfth Finance Commission to seven at present, as measured by the level of revenue deficit.

Implications and Framework for Revenue Deficit Consolidation:

The implications of these fiscal challenges on general government macroeconomic stability become apparent when considering the following fiscal statistics:

• The combined fiscal deficit of the aforementioned States stands at 3.71% of GSDP, compared to the all-State average of 2.9%. Similarly, their combined revenue deficit reaches 2.15% of GSDP, significantly higher than the all-State revenue deficit of 0.78%.
• Additionally, their combined debt ratio surpasses the Finance Commission-recommended debt ratio for all States in 2023-24. Considering these States’ significant contribution of around 40% to India’s GDP, preserving the fiscal stability of State finances becomes crucial to foster State-specific growth and sustain public and private investments.
• However, the resurgence of revenue deficits in recent years necessitates renewed attention and the establishment of an incentive-compatible framework for managing revenue deficits.
• Several measures can be considered:
  1. Linking interest-free loans from the Union Government to States with a reduction in revenue deficits can help eliminate the substitution of States’ own capital spending and prevent the diversion of borrowed resources for revenue expenditures.
  2. Implementing a defined time path for revenue deficit reduction, supported by a credible fiscal adjustment plan, would contribute to fiscal balance restoration and improve expenditure quality.
  3. Exploring forward-looking performance incentive grants that reward reductions in revenue deficits can be an effective approach. Drawing inspiration from the recommendations of previous Finance Commissions can aid in structuring the incentive framework.

Way Forward:

• To ensure fiscal stability and manage revenue deficits effectively, adopting a macro view becomes imperative. By focusing on revenue deficit management, aligning financial incentives, and incorporating long-term fiscal adjustment plans, States can achieve sustainable fiscal balance and promote economic growth.

Conclusion:

• The resurgence of revenue deficits in several major States demands concerted efforts to address the fiscal challenges at hand. By leveraging effective frameworks, incentivizing revenue deficit reduction, and emphasizing fiscal stability, States can foster a conducive environment for growth, while ensuring the efficient utilization of resources. A comprehensive analysis of revenue deficits, combined with a macro perspective, will enable effective management and lay the foundation for a robust fiscal landscape.