The Fiscal health of States

Syllabus: GS2/ Polity and Governance 

In Context

• It has been observed that States’ fiscal health improved after Covid-19 pandemic stress.

Fiscal position of States

• Size of the State’s revenue & expenditure
  • In India, the States mobilise 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%. 
  • Given the size of the fiscal operation of States, an up-to-date understanding of their finances is critical in order to draw evidence-based inferences on the fiscal situation of the country 
• Receding fiscal deficit:
  • It is becoming evident that the increase in general government deficit and debt that occurred during the COVID-19 pandemic has begun to recede. 
  • There have been significant post-pandemic fiscal corrections 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 (BE). 
    • All State fiscal deficit was 4.1% of GDP in 2020-21. It declined to 3.24% of GDP in 2022-23 (RE). 
    • For the major States, for the year 2023-24 (BE), it is expected to be 2.9% of GDP.
• Data collection:
  • The analysis here is based on the data collated from the individual Budgets of 17 major States. 
    • 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. 
• Fiscal consolidation
  • The analysis shows that these States together have managed to contain their fiscal deficits. This fiscal consolidation is significant in many ways. 
    • States in aggregate managed to be fiscally prudent despite a significant contraction in revenues even during the peak of COVID-19. 
    • Emergency provision for health spending and livelihood during the COVID-19 pandemic was not easy and required Union-State fiscal coordination. 
    • States were able to reprioritise expenditure and quickly contain the fiscal deficit. 
    • 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. 
    • Non-GST revenues are also showing signs of recovery after the pandemic in most States.

Challenges

• Absence of aggregating fiscal data:
  • Due to the absence of aggregation of individual State Budget data, a consolidated view of general government finances is not readily available. 
  • Every year, this data becomes available only after the publication of the Reserve Bank of India’s (RBI) Annual Study on State Finances. 
  • Aggregating fiscal data from individual State Budgets is rigorous and time consuming. 
    • Hence, the timeline of this publication by the RBI is during the second half of the fiscal year.
• Containing the revenue deficit of States:
  • The reduction in fiscal deficit has not been accompanied by a corresponding reduction in revenue deficit. 
    • As of 2023-24 (BE), out of 17 major States, 13 States have deficit in the revenue account. 
  • 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.
• Long-run implications of fiscal stress:
  • 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.
  • Increasing revenue deficit driving the fiscal imbalance has long-run fiscal implications and there is a need to correct this imbalance in the revenue account.

Suggestions & way ahead

• On the question of revenue deficit, a long-run view is also necessary. 
• 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, if continued, 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.
• A comprehensive revenue deficit reduction framework is essential to improve the fiscal health of States.
• In conclusion, we need to get the focus back on the management of revenue deficit. For this, a macro view is essential.