Context: 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.
Why is understanding state finances important?
- 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%.
Trends in Fiscal Health of Union and States
- Receding Government 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.
- Rising Revenue Deficit: 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.
- The number of States that are now fiscally stressed has increased to seven (measured in terms of the level of revenue deficit).
- For these seven States, their specific shares of revenue deficit in fiscal deficit for 2023-24 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%.
Significance of State’s Fiscal Consolidation
- Shows Fiscal Prudence: States in aggregate managed to be fiscally prudent despite a significant contraction in revenues even during the peak of COVID-19.
- Improved Union-State Coordination: Emergency provision for health spending and livelihood during the COVID-19 pandemic was not easy and required Union-State fiscal coordination.
- Reprioritising Expenditure: States were able to reprioritise expenditure and quickly contain the fiscal deficit.
- Buoyant Tax Revenues: 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.
- Recovery in Non-Tax Revenues: Non-GST revenues are also showing signs of recovery after the pandemic in most States.
- Rising Revenue Deficit: The reduction in fiscal deficit has not been accompanied by a corresponding reduction in revenue deficit. However, 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.
- As of 2023-24 (BE), out of 17 major States, 13 States have deficits 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.
- Increase in number of fiscally stressed states: 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 (measured in terms of the level of revenue deficit). The number of States that are now fiscally stressed has increased to seven.
- 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.
On the question of revenue deficit, a long-run view is also necessary. There is a need for creating an incentive compatible framework. The following measures can be considered.
- Going forward, interest-free loans to the States by the Union Government needs to 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 grant 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.
The seven fiscally stressed states together contribute around 40% to India’s GDP. Some of these States have also been big drivers of public capital expenditures and favoured investment destinations of private investors. Hence, the focus should be on the management of revenue deficit.