Fiscal Policy

MoSPI’s New CPI Framework for Inclusive and Accurate Price Measurement

The Consumer Price Index (CPI) is one of the most important indicators for measuring inflation, influencing monetary policy decisions, welfare schemes, and cost-of-living adjustments. Recently, the Ministry of Statistics and Programme Implementation (MoSPI) has proposed a significant revision in the methodology for calculating CPI, particularly in the housing component. The aim is to make the index more representative of real living conditions across both urban and rural India.

Background

Currently, housing has a weight of 21.67% in the urban CPI and 10.07% at the all-India level. However, this component is derived primarily from urban rental data and, in several cases, uses the House Rent Allowance (HRA) of government employees as a proxy for rent levels. Economists have pointed out that this approach fails to capture actual rental movements in growing smaller towns and does not account for rural housing dynamics, where ownership and imputed rent patterns differ significantly.

Key Proposed Changes

1. Inclusion of Rural Housing Data

For the first time, the CPI housing index will incorporate rental data from rural areas. This shift is based on the Household Consumption Expenditure Survey (HCES) 2023–24, which includes both actual rent paid and imputed rent for owner-occupied homes. This is important because rural India reports high home-ownership but also experiences value changes in housing that must be reflected in inflation estimates.

2. Exclusion of Employer-Provided Accommodation

Rent data from government or employer-provided dwellings will no longer be used. In such cases, HRA depends on administrative pay scales rather than the market rental environment. Their inclusion was leading to distorted inflation signals, particularly in metropolitan centers.

3. Monthly Rent Data Collection

The present methodology collects rental data only once in six months, leading to delayed or smoothed inflation readings. Under the revised framework, rent data will be collected monthly from all selected dwellings, improving the timeliness and sensitivity of the housing index.

4. Expanded Sampling and Global Best Practices

The revised framework draws on technical guidance from IMF experts, emphasizing panel-based rent tracking to maintain month-to-month comparability. This will reduce volatility and ensure a more stable and representative inflation measure.

Significance of the Reform

Enhances accuracy and responsiveness of CPI to real housing market changes
Improves representation of small towns and rural households
Strengthens economic planning and monetary policy calibration
Aligns India’s inflation measurement approach with global statistical standards

Conclusion

MoSPI’s revision to the CPI housing framework marks a major step toward inclusive and evidence-based inflation measurement.

By reflecting actual housing costs across diverse regions, the new methodology is expected to improve policy outcomes, welfare targeting, and the credibility of India’s inflation statistics.

NITI NCAER States Economic Forum

Context: NITI Aayog has launched the NITI NCAER States Economic Forum - a portal aggregating data and analysis on State finances.

Relevance of the Topic: Prelims: NITI NCAER States Economic Forum.

NITI NCAER States Economic Forum Portal

Developed by: NITI Aayog in collaboration with the National Council of Applied Economic Research (NCAER).
It is a comprehensive repository of data on social, economic, and fiscal parameters, research reports, papers, and expert commentary on state finances for a period of about 30 years from 1990-91 to 2022-23. Data is drawn from existing and credible sources like: Census 2011, Periodic Labour Force Survey (PLFS) and RBI’s State Finances Report

Components of the Portal

State Reports: Summarising the macro and fiscal landscape of 28 Indian States, structured around indicators on demography, economic structure, socio-economic and fiscal indicators.
- Presents macro-economic indicators: tax revenues, non-tax revenues, and trends in devolution of central funds.
- Includes human development statistics: literacy rates, school dropout rates, employment data.
Data Repository: Offers direct access to the complete database categorised across five verticals- Demography, Economic Structure, Fiscal, Health and Education.
State Fiscal and Economic Dashboard: Showcasing graphical representations of key economic variables over time and providing quick access to raw data.
Research and Commentary: Draws on extensive research on State finances and critical aspects of fiscal policy and financial management at the State and National levels.

Advantages of the Portal

Consolidated sectoral data at one place: Facilitate an understanding of macro, fiscal, demographic, and socio-economic trends.
Makes complex economic data user-friendly and accessible.
Allows for inter-state comparisons to assess development disparities and fiscal realities.
Serve as a comprehensive research hub for in-depth research studies.
By leveraging historical trends and real-time analytics, stakeholders can track progress, identify emerging patterns and formulate evidence-based policies for development.

The portal comes at a time of heightened debate on fiscal federalism, especially in southern States. It can shape discussions on revenue-sharing, parliamentary delimitation, and resource allocation by shifting the discourse to evidence-based policy.

Quality of Government Expenditure Index: RBI

Context: Recently, the Reserve Bank of India (RBI) has released the ‘Quality of Public Expenditure’ Index to assess how well the government is spending public money. The latest report makes for a positive picture.

Relevance of the Topic: Prelims: Quality of Public Expenditure Index; Public Expenditure- Trends & Analysis.

Quality of Public Expenditure (QPE) Index

Developed by the RBI to assess how well the government is spending public money.

The Index uses five variables to assess quality of spending:

Capital outlay to GDP ratio
Capital outlay to GDP ratio
Development expenditure to GDP ratio
Development expenditure measured as a percentage of a government’s total expenditure
Interest payments to total government expenditure ratio

Variables of Quality of Public Expenditure (QPE) Index

Capital outlay to GDP ratio:
- Money set aside by the government towards building physical infrastructure expressed as a percentage of Gross Domestic Product (GDP).
- The higher the ratio, the better is the quality of public expenditure (stronger commitment to enhance a nation's productive capacity).
Revenue expenditure to Capital outlay ratio:
- Relative weight of the revenue & capital expenditures. Compares day-to-day operational expenses of the government (like salaries, subsidies, pensions) to the long-term capital investment.
- The lower the value of this ratio, the better is the quality of public expenditure.
Development expenditure to GDP ratio:
- Development expenditure refers to all public expenditure to enhance production factors (labour and capital) or by improving their productivity, in order to stimulate economic growth.
- It includes expenditure on:
  - Education and training
  - Public infrastructure investments
  - R&D (which drives technological advancement and innovation)
  - Healthcare (which boosts both the size and productivity of the labour force by extending the span of healthy life).
  - Subsidies (particularly those aimed at improving nutrition, such as food subsidies) to bring long-term welfare gains.
Development expenditure as a percentage of a government’s total expenditure: The higher the value of this ratio, the better is the quality of public expenditure.
Interest payments to total government expenditure ratio:
- Proportion of government spending on servicing debt.
- A lower value of this ratio shows better quality of public spending.

Quality of India’s Public Expenditure: Analysis by RBI

The RBI has broken the whole period (from 1991 to now) in six phases to illustrate how structural forces have shaped the quality of public expenditure at both levels of government (Centre & states).

Phase 1: Early Post-Liberalisation Reforms & Fiscal Realignments (1991-95):
- Centre’s index (Chart 1) showed a slight improvement in quality of public expenditure (QPE), while the States’ index (Chart 2) declined modestly. These movements were driven by the fiscal pressures faced by both levels of government.
- Public investment fell as fiscal consolidation took precedence.
Phase 2: Pre- FRBM Consolidation (1996-2003):
- Both indices experienced a sharp decline reflecting the combined impact of the Fifth Pay Commission implementation, rising interest payments, and the persistent dominance of revenue expenditure over capital outlay.
Phase 3: FRBM Implementation & Growth Upswing (2003-2008):
- Reflects positive effects of both fiscal discipline (as FRBM Act started guiding government borrowing) and fast economic growth making more money available for spending.
- States also benefited from higher fiscal devolution.
- The index rebounded sharply until the world was hit by the Global Financial Crisis (GFC) of 2008.
Phase 4: Global Financial Crisis & Countercyclical Adjustments (2008-13):
- GFC prompted the Centre to adopt countercyclical fiscal measures, including stimulus packages.
- Governments, especially the Centre had to spend more in order to counter the slowdown and hurt caused by the GFC.
- While this continued to push up the index during this phase, higher spending levels resulted in higher deficits, and it eventually started eroding the quality of public expenditure.
Phase 5: Structural Reforms & GST Rollout (2013-20):
- The trajectory of the index goes in opposite directions for the Centre and the states.
- The QPE saw an improvement in states with improvements in development spending, as well as more money being available to them, thanks to the recommendations of the 14th Finance Commission.
- The Centre further faced challenges with GST revenue sharing initially favouring the states.
Phase 6: Pandemic shock & Infrastructure-focused recovery (2020-Present):
- Economic recovery especially driven by the heightened focus on capital expenditure helped push up the quality of public expenditure.

Thus, according to RBI’s index, the quality of public expenditure in India (both at Centre and state levels) is close to the highest point it has ever been since the start of economic liberalisation in 1991.

Recent Trend shifts in India’s Public Expenditure

Push for Fiscal Discipline:
- To limit the tendency in government to overspend, India instituted the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.
- FRBM limit on Fiscal & Revenue Deficit:
  - As per FRBM Act, the fiscal deficit should ideally not exceed 3% of GDP.
  - The revenue deficit should be zero.
  - Purpose: Government should only borrow for capital expenditure (and not for paying higher salaries and other similar everyday spending).
- Targeting overall debt: India has now shifted to targeting overall debt as a percentage of GDP, instead of an individual year’s fiscal deficit, as a way to maintain fiscal discipline.
Push for higher capital expenditure: Capex boosts productive capacity of the economy.

Also Read: Re-evaluating FRBM Act 2003

India needs to enhance the Quality of Public Expenditure by continued investment in infrastructure, renewable energy, and digital transformation, keeping borrowing under control, strengthening Centre-state financial coordination and using data-driven governance models to track expenditure efficiency.

Re-evaluating FRBM Act 2003

Context: The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was enacted to ensure macro-economic stability and inter-generational equity. The Act's rigid framework has been increasingly criticised for its limitations, especially during the times of economic crises.

Relevance of the Topic: Prelims: Key features of FRBM Act, 2003. Mains: FRBM Act- Limitations, Reforms.

Fiscal Responsibility and Budget Management (FRBM) Act, 2003:

The Act aims to ensure a balance between government revenue and government expenditure. It set deficit targets for the Union and States to control their deficits.
Objectives:
- Ensuring fiscal discipline.
- Efficient management of expenditure, revenue and debt.
- Promoting macroeconomic stability.
- Better coordination between fiscal and monetary policy.
- Increasing transparency in the fiscal operation of the Government.

Salient Features of Fiscal Responsibility and Budget Management Act, 2003

Section 4(1) of the FRBM Act provides that the Central Government shall:
- Take measures to limit the fiscal deficit up to 3% of GDP.
- Ensure that by the end of Financial Year 2024-25:
  - General Government debt does not exceed 60% of GDP.
  - Central Government debt does not exceed 40% of GDP.
- Not give additional guarantees with respect to any loan on security of the Consolidated Fund of India in excess of one-half per cent of GDP, in any Financial Year.
- Ensure that the fiscal targets are not exceeded after stipulated target dates.
Under Section 5 of the Act, except for certain circumstances, the Act does not allow the Central Government to borrow from the Reserve Bank of India (RBI).

FRBM Review Committee headed by NK Singh

The government believed the targets set by the FRBM Act were too rigid. In 2016, the government set up a committee under NK Singh to review the FRBM Act. Targets set by NK Singh Committee:

Debt to GDP ratio:
- The Committee suggested using debt as the primary target for fiscal policy.
- It advocated for a Debt to GDP ratio of 60% with a 40% limit for the centre and a 20% limit for the states.
Revenue Deficit Target:
- It should be reduced to 0.8% of GDP by March 31, 2023. The minimum annual reduction target was 0.5% of GDP.
Fiscal Deficit Target:
- The government should target a fiscal deficit of 3 percent of the GDP in the years up to March 31, 2020, cut it to 2.8 per cent in 2020-21.
- It should be reduced to 2.5% of GDP by March 31, 2023. The minimum annual reduction target was 0.3% of GDP.

FRBM Act – Escape Clause

The FRBM Act was amended in 2018, adding specific details that were given in Section 4(2).
If the escape clause is triggered, RBI is then allowed to participate directly in the primary auction of government bonds, thus formalising deficit financing.
- Deficit financing refers to the method of financing the budget deficits — such as issuing bonds or printing more money.
FRBM Act Section 4(2), provides for a trigger mechanism to escape deficit control–related clauses in the act and the Government can over cross the targets in the following situations:
- National Security / Act of War
- National Calamity
- If agriculture output and farm incomes collapse
- Fall in real output/GDP growth rate beyond x%
- Structural reforms in the economy with unanticipated fiscal implications.
During the above trigger conditions:
- The government may over cross/deviate from the fiscal deficit target by up to 0.5% of GDP, as recommended by NK Singh’s FRBM Review Committee.
- Individual State Governments may also do similar (E.g., overcross by 0.5% of GSDP), after amending the state FRBM Act accordingly.
The Finance Minister cited structural reform to escape the FRBM targets for 2019-20 and 2020-21.
In Budget-2021, FRBM was amended to provide a fiscal deficit target of 4.5% by 2025-26, as recommended by the 15th FC.

Documents Mandated by FRBM Act

Macroeconomic Framework Statement: This statement provides an overview of the economy, including GDP growth, inflation, receipts and expenditure.
Medium-Term Fiscal Policy Statement: This statement sets out the government’s fiscal policy goals for the medium term.
Fiscal Policy Strategy Statement: This statement explains how the government plans for fiscal policy goals.
Medium-Term Expenditure Framework: This framework sets out the government’s spending plans for the medium term.

2024-25: Budget Estimates vs. Revised Estimates

Revenue Receipts: There is a decline in revenue receipts, which could increase the revenue deficit by 0.8% of GDP. This would mean the government is saving less, which negatively impacts economic growth.
Capital Expenditure: Capital expenditure is also expected to decline by 1.1% of GDP. This will slow down economic growth further.
Impact on Growth: The combined effect of the decline in revenue receipts, non-debt capital receipts, and capital expenditure has already contributed to a decrease in real economic growth from 8.2% in 2023-24 to 6.4% in 2024-25.
Fiscal Deficit: The decline in revenue receipts and capital expenditure, along with a drop in non-debt capital receipts, is expected to slightly increase the fiscal deficit-to-GDP ratio.

Way Forward

2025-26 Budget should aim to amend the FRBM targets by:

Eliminating the revenue deficit:
- The government should aim to eliminate the revenue deficit by 2027-28. This will help increase savings and support economic growth.
Reducing the fiscal deficit to 3% of GDP:
- The fiscal deficit should be reduced to 3% of GDP within the next three years.
Reducing the debt-to-GDP ratio to 50% over the next three years.
- The current rule of a 40% debt-to-GDP ratio is strict.
- The government should consider reducing it to 50% from the current 56.8% (estimated for 2024-25) over the next three years.
Introducing a rule to ensure that capital expenditure stays at 3% of GDP.
- The government often plans high capital expenditure in the budget but later reduces it, which distorts fiscal management. To fix this, the government should set a clear target for capital expenditure at 3% of GDP.

Understanding the formulation of Union Budget

Context: The Union Budget will be tabled in Parliament by the Finance Minister on 1st February, 2025. It is likely to address concerns around growth, inflation and spending.

Relevance of the Topic:Prelims: Key concepts related to Union Budget- Components; Deficits- Fiscal, Revenue, Primary deficit.

Union Budget in India

The budget is the government’s blueprint on expenditure, taxes it plans to levy, and other transactions which affect the economy and lives of citizens.
Constitutional framework: According to Article 112 of the Indian Constitution, the Union Budget of a year is referred to as the Annual Financial Statement (AFS).
Formulation: The Budget Division of the Department of Economic Affairs in the Finance Ministry is the nodal body responsible for preparing the Budget.

Components of Budget

There are three major components— expenditure, receipts and deficit indicators. Depending on the manner in which they are defined, there can be many classifications and indicators of expenditure, receipts and deficits.

Expenditure	1. Based on Asset Creation and Liability Reduction: Capital Expenditure: Incurred with the purpose of increasing assets of a durable nature or of reducing recurring liabilities. Example: Expenditure incurred for constructing new schools or new hospitals. Revenue Expenditure: involves any expenditure that does not add to assets or reduce liabilities. Example: Expenditure on the payment of wages and salaries, subsidies or interest payments. 2. Based on Sectoral Impact:Expenditure is also classified into: General services: Includes administrative expenses, defence, interest payments etc. Economic services: Includes expenditure on transport, communication, rural development, agricultural and allied sectors.Social services: Includes expenditure on the social sector including education or health. Grants-in-aid and contribution.The sum of expenditure on economic and social services together form the development expenditure.
Receipts	Receipts of the Government have three components: -Revenue receipts -Non-debt capital receipts - Debt-creating capital receipts. Revenue receipts involve receipts that are not associated with increase in liabilities and comprise revenue from taxes and non-tax sources. Non-debt receipts are part of capital receipts that do not generate additional liabilities. Example: Recovery of loans and proceeds from disinvestment. Debt-creating capital receipts involve higher liabilities and future payment commitments of the Government.
Fiscal Deficit	Fiscal deficit is the difference between total expenditure and the sum of revenue receipts and non-debt receipts. It indicates how much the Government is spending in net terms. Positive fiscal deficits indicate the amount of expenditure over and above revenue and non-debt receipts. It needs to be financed by a debt-creating capital receipt. Primary deficit is the difference between fiscal deficit and interest payments. Revenue deficit is derived by deducting capital expenditure from fiscal deficits.

Implications of Budget on Economy

Impact on Aggregate Demand:
- Expenditure: All Government expenditure generates aggregate demand in the economy, since it involves purchase of private goods and services by the Government sector.
- Receipts: All tax and non-tax revenue reduces net income of the private sector, and thereby leads to reduction in private and aggregate demand.
- Reducing aggregate demand: Following cases indicates the Government’s policy to reduce aggregate demand:
  - Reduction in expenditure-GDP ratio
  - Increase in revenue receipt-GDP ratio
  - Reduction in fiscal deficit-GDP and primary deficit-GDP ratios.
- Increasing aggregate demand: Following cases indicates the Government’s policy to increase aggregate demand:
  - Increase in expenditure-GDP ratio
  - Decrease in revenue receipt-GDP ratio
  - Increase in fiscal deficit-GDP and primary deficit-GDP ratios
Impact on Income Distribution:
- Revenue expenditure such as employment guarantee schemes or food subsidies can directly boost the income of the poor.
- Concession in corporate tax may directly and positively affect corporate incomes.

What are Fiscal rules?

Fiscal rules provide specific policy targets on the basis of which fiscal policy is formed.
Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth.
Policy targets can be met by using different policy instruments.
- There exists no unique fiscal rule that is applied to all countries.
- Rather, policy targets are sensitive to the nature of economic theory and depend on the specificity of an economy.

Fiscal Rules in India

India’s present fiscal rule is guided by the recommendations of the N.K. Singh Committee Report.
Allowing for some deviations under exceptional times, it has three policy targets:
- Stock Target: maintaining a specific level of debt-GDP ratio
  - The total amount of debt a country has compared to its GDP.
  - This shows how much a country owes to what it produces.
  - If debt is too high, it can lead to financial instability.
- Flow Target: Fiscal deficit-GDP ratio
  - The gap between how much the government spends and how much it earns in a year, compared to its GDP.
  - A high fiscal deficit means the government is borrowing more to cover its expenses.
- Composition Target: Revenue deficit-GDP ratio
  - The part of the fiscal deficit that comes from borrowing for regular expenses instead of investments.
Governments can manage their finances in 2 ways:
- Changing tax rates
- Adjusting spending
However, in India, tax-rates within the existing policy framework are determined independent of the expenditure requirement of the economy. So, when the government needs to meet fiscal targets, it mainly adjusts its spending instead of changing taxes.

How India’s fiscal rules affect fiscal policy?

Spending limits: Independent of the extent of expenditure needed to stimulate the economy or boost labour income, existing fiscal rules provide a cap on expenditure by imposing the three policy targets.
Rigid Targets: Under any situation when the debt-ratio or deficit ratio is greater than the targeted level, expenditure is adjusted in order to meet the policy targets. Thus, independent of the state of the economy and the need for expansionary fiscal policy, existing policy targets may lead the Government to reduce expenditure.

In the midst of the inadequacies of fiscal policy to address the contemporary challenges of unemployment and low output growth rate, the nature and objective of fiscal rules in India would have to be re-examined.

Centre’s Share in States’ Revenue has surged

Context: Over the last decade, States have been relying more and more on transfers and grants from the Centre. The falling efficiency of States in collecting more taxes has deepened their dependency on the Centre.

Relevance of the Topic:Prelims: States’ sources of revenue- Key Facts, Trends Analysis.

What are the sources of Revenue for States?

1. States’ share of Central Taxes:

According to the Constitution, the Union Government is required to share a part of all the tax revenue that it raises with State Governments.
This part of the tax collection that the Central Government shares with State Governments is known as the States’ Share in Central Taxes.

2. States’ Own Tax Revenue (OTR):

There are many taxes that are either levied by State Governments, or where the collection goes directly to State Governments.
- Except Goods and Services Tax (GST), the rates of such taxes are determined by State Governments. Hence, there is a variance across States.
Goods and Services Tax (GST):
- Components of the total GST collection, known as State GST (SGST) and part of integrated GST (IGST) goes directly to State Governments.
State Excise Duty:
- Levied on the production of goods that are not under GST.
- After the introduction of GST, the main item on which State excise duty is applied is alcohol.
Sales tax and VAT:
- There are certain items whose sale is not covered by GST.
- The sale of such items falls under the State sales tax or State value added tax (VAT).
Stamps and Registration Duty:
- This is generally levied on the sale of land and/or immovable properties such as flats/houses/buildings.
Vehicle Registration Tax:
- Applied on the registration of new vehicles or in the case of a change in the ownership of a vehicle.
Entertainment Tax:
- This levy is generally applied on the sale of movie tickets, etc.

3. States’ Non-Tax Revenue:

Lease/sale of natural resources:
- States can either sell or lease out natural resources for the economic purposes for which they receive receipts.
- Lease of minerals is a major source for many states, such as Odisha, Jharkhand and Chhattisgarh, among others.
Economic services:
- There are certain services provided by the government for which it charges the user, such as - irrigation, health, education, forestry and wildlife, etc.
- The user charges are not done with the purpose of profit, and are generally much lower than the charges by the private sector.
- Nonetheless, they do provide some revenue to the government.
Sale of lotteries:
- Some states engage in the activity of selling lotteries
- The net proceeds from these goes to the government funds.
Interest receipts:
- State governments can provide loans to certain entities like public sector undertakings (PSUs), local bodies, etc.
- Interest receipts are the interest received on such loans.

Trends of States’ revenue share among different sources

Increasing share of Transfers from Centre:
- In the last decade (FY16 to FY25), 23-30% of the total revenue of States was collected from the Centre as transfers.
- However, in the 2000s and 2010-15, the share was 20-24%.
Increasing share of Grants from Centre in States’ non-tax revenue:
- 65-70% of the non-tax revenue of States was collected from the Centre as grants in the last decade.
- In the 2000s and 2010-15, the share was lower at 55-65%.
Diminishing share of non-tax revenue:
- Revenue from non-tax revenue, other than Central grants, has been diminishing. This share is likely to go below the 24% mark in FY25 for the first time in the past 25 years.
- Interest receipts have not exceeded 5% of non-tax revenues in the last decade.
  - Compared to the 2000s and first half of 2010, when it formed 5-9% of non-tax revenue.
- The share of dividends and profits garnered from State public sector enterprises has remained under 1%.

Stagnant Own Tax Revenue:
- States have also not done enough to efficiently collect taxes to increase their own tax revenue.
- For over a decade now, States’ own tax revenue as a share of their total revenue has remained considerably below 50%.
- In the 2000s and in the early 2010s, it had crossed the 50% mark for many years or remained close to it.
SGST-driven Own-Tax Revenue:
- While SGST accounted for 15% of the States’ total revenue in FY18, it currently makes up about 22%.
- Consequently, the share of own tax revenue, without the contribution from SGST, has declined from 34% to 28%.
- What it implies: Share of States’ own tax revenue is not only consistently below the 50% mark, but also an increasing share of it is derived from SGST.

A marked decline in ratio of select States’ own tax revenue to its GSDP:
- For Tamil Nadu, the own tax revenue to GSDP ratio has gradually declined from 7.72% in FY13-15 to 6.17% in FY 22-24. This has also been the case in Karnataka, Kerala, Bihar, Delhi, and Madhya Pradesh, too.
- While the ratio has risen in Maharashtra, Manipur, Meghalaya, Odisha, and Uttarakhand, it has remained stagnant in other States.

Concerns

The combination of these factors indicates increasing dependency of States on Central funds.
- The Centre is playing a major role in the revenue earned by the States.
- However, it is also true that many States are not efficiently collecting taxes using avenues at their disposal.
While expenditure responsibilities have been rapidly spiralling, the nearly stagnant own tax revenue mobilisation impedes the States’ counter-cyclical expansionary fiscal measures in a sustained manner to boost aggregate demand in the economy.

RBI asks States to sustain Fiscal Prudence

Context: Recently, the Reserve Bank of India (RBI) has released a report on “State Finances — A Study of Budgets of 2024-25.” The report emphasises the need for sustained fiscal prudence to states while prioritising growth-enhancing capital spending.

Relevance of the Topic: Prelims: Key facts related to fiscal deficit, debt management, Fiscal Responsibility and Budget Management (FRBM) Act.

Observations by RBI:

1. Positive Trends:

Rising Capital Expenditure: Capital expenditure increased from 2.4% of GDP (2021-22) to 2.8% (2023-24) and budgeted at 3.1% of GDP in 2024-25. This reflects improvement in the quality of expenditure.
Deficit Management: State governments have contained their gross fiscal deficit (GFD) within 3% of GDP (gross domestic product) and Revenue deficit at 0.2% of GDP during 2022-23 and 2023-24.
Declining Debt levels: States’ total outstanding liabilities have declined from 31.% of GDP (March 2021) to 28.5% at March 2024.
Policy Reforms: State-specific fiscal responsibility legislations (FRLs), along with tax and expenditure reforms have strengthened states’ finances over the past two decades.

2. Concerns:

Rise in Subsidies burden: There is a sharp rise in expenditure on subsidies, driven by:
- farm loan waivers
- free/subsidised services (like electricity to agriculture and households, transport, gas cylinder)
- cash transfers to farmers, youth and women.
Too many Central government schemes reduce flexibility of State government spending and dilute the spirit of cooperative fiscal federalism.
Persistent high level of subnational debt calls for a credible roadmap for debt consolidation.
- Through the states’ total outstanding liabilities have declined to 28.5% (March 2024), but they still remain:
  - above the pre-pandemic level (25.3% at end-March 2019).
  - above the 20% ceiling by Fiscal Responsibility and Budget Management (FRBM) Act, 2017.

Suggestions by RBI:

States need to rationalise their subsidy outgoes so that subsidy spending does not crowd-out capital expenditure.
Rationalisation of centrally sponsored schemes to free up budgetary space to meet State-specific expenditure and reduce fiscal burden of both Union and State governments.
Develop a transparent and time-bound debt consolidation roadmap, aligned with macroeconomic objectives such as debt sustainability, resilience, and fiscal flexibility.
Consistent reporting of contingent liabilities and off-budget borrowings to enhance fiscal transparency and aid in assessing fiscal health of States.
Improving public expenditure efficiency by implementing outcome budgeting, i.e., linking spending to measurable outcomes.
Adoption of climate budgeting to integrate climate action into fiscal planning.
Leverage technologies like artificial intelligence and machine learning to utilise micro-data generated by state departments for improved public policy and better governance.
Timely and adequate transfers to local bodies by States to strengthen decentralised governance. A multi-pronged approach is required to refine the process of appointment of State Finance Commissions (SFCs), data collection and improving the quality of SFC reports.

Conclusion: Overall, the State governments have made progress in fiscal consolidation, there is scope for further improvement in expenditure efficiency, outcome and climate budget, transparent data reporting and use of modern techniques. Efforts by States in these areas will pave the way for higher economic growth with macroeconomic stability.

Capital Gains Tax

Context: The Government in the Budget of 2024-25 has announced an increase in capital gains tax for both short-term and long-term transactions.

What are Capital Assets?

Land, building, house property, vehicles, patents, trademarks, leasehold rights, machinery, and jewellery are a few examples of capital assets.
The following do not come under the category of ‘capital asset’:
- Any stock, consumables or raw material, held for the purpose of business or profession.
- Personal goods such as clothes and furniture held for personal use
- Agricultural land in rural India
- 6.5% gold bonds (1977) or 7% gold bonds (1980) or National Defence gold bonds (1980) issued by the central government
- Special bearer bonds (1991)
- Gold deposit bonds issued under the gold deposit scheme (1999) or deposit certificates issued under the Gold Monetisation Scheme, 2015 and Gold Monetisation Scheme, 2019 notified by the Central Government.

What is Capital Gains Tax in India?

Any profit or gain that arises from the sale of a ‘capital asset’ is known as ‘income from capital gains’. Such capital gains are taxable in the year in which the transfer of the capital asset takes place. This is called capital gains tax.
There are two types of Capital Gains: short-term capital gains (STCG) and long-term capital gains (LTCG).

Changes Made in the Budget 2024-25

The limit on the exemption of LTCG on certain asset classes (transfer of equity shares or equity-oriented units or units of Business Trust) has increased from Rs.1 Lakh to Rs.1.25 lakh per year.
For classifying assets into long-term and short-term, there will only be two holding periods: 12 months and 24 months.
The holding period for all listed securities is 12 months. All listed securities with a holding period exceeding 12 months are considered Long-Term. The holding period for all other assets is 24 months.
The taxation of Short-Term Capital Gain (STCG) for listed equity shares, a unit of an equity-oriented fund, and a unit of a business trust has been increased from 15% to 20%.
The tax on long-term capital gains (LTCG) on other financial and non-financial assets is reduced from 20% to 12.5%. While on the other hand, the indexation benefit that was previously available on sale of long-term assets, has now been done away with.

Bad Loans at Record Low

Context: In the second quarter of 2019, the NPA ratio of Indian banks was 9.2% which was the worst among most emerging economies. However in the span of just four years, the GNPAs and Net NPAs have now reached their lowest levels since 2015 to 3.9% and 1%, respectively.

Basics of Bad Assets

Non-Performing Assets (NPA): An asset that is not returning in the form of principal or interest during the last 90 reporting days is classified as NPA.
Gross Non-Performing Assets (GNPA): GNPA is an absolute amount which reflects the total value of non-performing assets for the bank in a particular financial year.
Net Non-Performing Assets (NNPA): NNPA subtracts the provisions made by the bank from the gross NPA. Hence, net NPA gives you the exact value of non-performing assets after the bank has made specific provisions for it.
Return of Asset (RoA): RoA is calculated by dividing the net income of a bank by its total assets. An RoA of >=1% is generally considered good.
Provisioning is a mechanism to deal with bad assets. Under provisioning, banks have to set aside some funds to a prescribed percentage of their bad assets. The percentage of bad assets that has to be ‘provided for’ is called provisioning coverage ratio. The provisioning coverage ratio is the percentage of bad assets that the bank has to provide for from their own funds – most probably from profit.
Capital Adequacy Ratio (CAR) also known as capital-to-risk weighted assets ratio (CRAR) is defined as the proportion of a bank's total assets that is held in the form of shareholders' equity and certain other defined classes of capital. It is a measure of the bank's ability to meet the needs of its depositors and other creditors. It is expressed as a percentage of a bank's weighted credit exposures.

Facts that Shows the Decline in Stressed Assets

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This graph shows that GNPAs and Net NPAs continued to decline and in March 2023, reached 3.9% and 1%, respectively, the lowest levels since 2015.

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Chart above shows that the profitability of the banking sector has seen a marked improvement, with the Return on Assets (RoA) climbing to 1.1% in 2023, up from a negative 0.2% in 2018. An RoA of >=1% is generally considered good. This positive shift has contributed to the Capital to Risk-Weighted Assets Ratio (CRAR) hitting a record peak of 17.1% in 2023. A key indicator of a bank’s health is its capital position, especially its CRAR that measures the bank’s exposure to riskier loans.

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The graph above illustrates the ratio of write-offs to GNPAs, which had been on a consistent downward trend during 2020-21 and 2021-22. However, there was a rise in this ratio in 2022-23, primarily due to substantial write-offs by private sector banks.

It shows the GNPA ratio of personal loans by category. The ratio has declined against all types of personal loans such as housing, credit cards, vehicle loans, and education loans.

Reasons For Declining NPAs

The Insolvency and Bankruptcy Code helped the recovery of sick loans.
Banks have stopped lending big money to industries and increased their share of personal loans.
Drop in Slippage Ratio: The slippage ratio is the rate at which good loans are turning bad. It is measured by

Fresh accretion of NPAs during the year × 100

Total standard assets at the beginning of the year

The slippage ratio was around 2% in September 2022 for SCBs, which is the lowest since 2015. Low slippage shows how well the asset qualities are managed by the bank.
Increasing Write-offs: Banks voluntarily choose to write off NPAs to maintain healthy balance sheets. According to the data given by the finance ministry, banks had written-off bad loans worth ₹ 10,09,511 crore in the last 5 years. In the first half of FY 2022-23, the loan write-offs as a ratio of GNPAs increased to 22.6%.

These factors not only helped in reducing the share of bad assets but also increased the profitability of scheduled commercial banks in the last one year.

Conclusion

Hence, from the above analysis, we can conclude that the recovery of banks is consistent and their health continues to improve.

Scheme for Special Assistance to States for Capital Investment 2023-24

Context: The Department of Expenditure, Ministry of Finance, Government of India, has approved capital investment proposals of Rs. 56,415 crore in 16 States in the current financial year. Approval has been given under the scheme entitled ‘Special Assistance to States for Capital Investment 2023-24’.

About the Scheme

In view of a higher multiplier effect of capital expenditure and in order to provide a boost to capital spending by States, the scheme ‘Special Assistance to States for Capital Investment 2023-24' was announced in the Union Budget 2023-24.
Under the scheme, special assistance is being provided to the State Governments in the form of 50-year interest free loan for capital investment projects up to an overall sum of Rs. 1.3 lakh crore during the financial year 2023-24.

Components of the Scheme

Part I: It is the largest part having the allocation of Rs. 1 lakh crore. This amount has been allocated amongst States in proportion to their share of central taxes & duties as per the award of the 15th Finance Commission. Other parts of the scheme are either linked to reforms or are for sector specific projects.
Part II: In this part of the scheme, an amount of Rs. 3,000 crore has been set aside for providing incentives to States for scrapping of State Government vehicles and ambulances, waiver of liabilities on old vehicles, providing tax concessions to individuals for scrapping of old vehicles and setting up of automated vehicle testing facilities.
Part III & IV: This part aims at providing incentives to States for reforms in Urban Planning and Urban Finance. An amount of Rs. 15,000 crore is earmarked for Urban Planning Reforms, while additional Rs. 5,000 crore is for incentivising the States for making Urban Local Bodies creditworthy and improving their finances.
Part V: This aims at increasing the housing stock for the police personnel and their families within the police stations in urban areas. An amount of Rs. 2,000 crore is earmarked for this purpose under the scheme.
Part VI: Another objective of the Scheme is to promote national integration, carry forward the concept of “Make in India” and promote the concept of “One District, One Product (ODOP)” through construction of Unity Mall in each State. An amount of Rs. 5,000 crore has been set aside for this purpose under the scheme.
Part-VII: of the Scheme, with an allocation of Rs. 5,000 crore is for providing financial assistance to States for setting up libraries with digital infrastructure at Panchayat and Ward level for children and adolescents.
Part VIII of the scheme incentivises States for implementation of “Just-in-Time” release of Centrally Sponsored Schemes (CSS) funds by State Government to vendors and beneficiaries using RBI’s e-Kuber Model and for timely release of Central & State share of funds to Single Nodal Agency accounts.

Conditions to be Fulfilled by States

The scheme guidelines include mandatory conditions which the States need to fulfil in order to avail benefits under any Part of the Scheme. These are:

Full compliance with the official name of all CSSs and any guidelines/instructions issued by the Government of India regarding branding of CSSs, in all schemes of all ministries. However, correct translation of the official name of CSSs in local language is permitted.
Integration of State treasuries with Public Finance Management System (PFMS) and exchange of data between State treasuries and PFMS in respect of all State Linked Scheme for CSS in a state for which the state has received funds from the Central Government in the past 21 days.
Deposit of central share of interest earned in Single Nodal Agency accounts till 31st March, 2023 in the Consolidated Funds of India and submission of certificate to this effect in the format, signed by the Finance Secretary of the State Government.

CBDC more environment friendly than other cashless modes: RBI report

Context: Central bank digital currency (CBDC) or e-rupee, if designed keeping in mind the environment, social and governance (ESG) objectives, can be more environment friendly compared to alternative cashless methods, according to the RBI report.

CBDC and environment

CBDCs are significantly more energy efficient than current credit card processing centres, in part because the latter involve energy-inefficient legacy systems.
CBDC helps curb emissions by nullifying operations such as printing, storage, transportation, and replacement of physical currency.
Results of a climate stress-test revealed that public sector banks (PSBs) may be more vulnerable than private sector banks (PVBs) in India.

Climate-stress tests are scenario based exercises that assess the loss to the financial systems/entities due to climate related risks by adopting the methodology of traditional stress tests to climate related exigencies.

All about Central Bank Digital Currency

Central Bank Digital Currency (CBDC) is a digital form of currency notes issued by a central bank. The e₹ will provide an additional option to the currently available forms of money.
It is akin to sovereign paper currency but takes a different form, exchangeable at par with the existing currency and shall be accepted as a medium of payment, legal tender and a safe store of value. CBDCs would appear as liability on a central bank’s balance sheet. That is, a central bank liability, denominated in an existing unit of account, which serves both as a medium of exchange and a store of value.
It is substantially not different from banknotes, but being digital it is likely to be easier, faster and cheaper. It also has all the transactional benefits of other forms of digital money.
CBDC, being a sovereign currency, holds unique advantages of central bank money viz. trust, safety, liquidity, settlement finality and integrity.

The features of CBDC include

CBDC is sovereign currency issued by Central Banks in alignment with their monetary policy
It appears as a liability on the central bank’s balance sheet
Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies.
Freely convertible against commercial bank money and cash
Fungible legal tender for which holders need not have a bank account
Expected to lower the cost of issuance of money and transactions

Type of CBDC to be issued

CBDC can be classified into two broad types viz. general purpose or retail (CBDC-R) and wholesale (CBDC-W). Retail CBDC would be potentially available for use by all viz. private sector, non-financial consumers and businesses while wholesale CBDC is designed for restricted access to select financial institutions. While Wholesale CBDC is intended for the settlement of interbank transfers and related wholesale transactions, Retail CBDC is an electronic version of cash primarily meant for retail transactions.
It is believed that Retail CBDC can provide access to safe money for payment and settlement as it is a direct liability of the Central Bank. Wholesale CBDC has the potential to transform the settlement systems for financial transactions and make them more efficient and secure. Going by the potential offered by each of them, there may be merit in introducing both CBDC-W and CBDC-R.

Model for issuance and management of CBDC

There are two models for issuance and management of CBDCs viz. Direct model (Single Tier model) and Indirect model (Two-Tier model). A Direct model would be the one where the central bank is responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification.
In an Indirect model, central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model central bank issues CBDC to consumers indirectly through intermediaries and any claim by consumers is managed by the intermediary as the central bank only handles wholesale payments to intermediaries.
The Indirect model is akin to the current physical currency management system wherein banks manage activities like distribution of notes to public, account-keeping, adherence of requirement related to know-your-customer (KYC) and anti-money laundering and countering the terrorism of financing (AML/CFT) checks, transaction verification etc.

Forms of CBDC

CBDC can be structured as ‘token-based’ or ‘account-based’.
A token-based CBDC is a bearer-instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them.
In contrast, an account-based system would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances.
Also, in a token-based CBDC, the person receiving a token will verify that his ownership of the token is genuine, whereas in an account-based CBDC, an intermediary verifies the identity of an account holder.
Considering the features offered by both the forms of CBDCs, a token-based CBDC is viewed as a preferred mode for CBDC-R as it would be closer to physical cash, while account-based CBDC may be considered for CBDC-W.

Advantages of CBDC over other digital payments systems

As it being a sovereign currency, ensures settlement finality and thus reduces settlement risk in the financial system.
CBDCs could also potentially enable a more real-time, cost-effective seamless integration of cross border payment systems.
The payment systems are available 24X7, 365 days a year to both retail and wholesale customers.
They are largely real-time, the cost of transaction is perhaps the lowest in the world, users have a wide array of options for doing transactions and digital payments have grown at an impressive CAGR of 55% over the last five years.
The e₹ system will bolster India’s digital economy, cashless economy, enhance financial inclusion, and make the monetary and payment systems more efficient.
CBDCs could ease current frictions in cross-border payments.
Traceability of transactions would crack down on corruption and money laundering.
Counter the monopoly of private sector issued cryptocurrencies.

State’s fiscal space

Off-budget borrowings

Off-budget borrowings or off-budget financing generally refer to use of those financial resources by the Government for meeting expenditure requirements, which are not reflected in the budget for seeking grant/appropriation, hence remaining outside legislative control. These are financed through Government owned public sector enterprises, which raise the resources through market borrowings on behalf of the Government.

However, the Government is to repay the debt or service the debt from its budget. Therefore, off-budget borrowings involve

Payment of interest on recurrent basis and
Repayment of the borrowings from budget as and when it is due.

Reasons for rise in Off-budget borrowings:

Constrained revenue growth due to the pandemic-induced slowdown and increasing revenue expenditure have led to widening of states' fiscal deficits. This has reduced the wherewithal of states to directly fund the entities they own.
Even if states wanted to borrow more, they couldn’t without the explicit approval of, and beyond the limits set by, the central government.

Borrowing by the States:
Article 293(3): A State cannot raise any loan without the consent of the Government of India if there is still outstanding any part of a loan which has been made to the State by the Government of India, or in respect of which a guarantee has been given by the Government of India. A consent under this clause may be granted by the centre subject to some conditions.The Centre has allowed States to borrow up to 3.5% of their respective state GDP and an additional 0.5% if they implement mandated power sector reforms.

Centre’s norms on Off-budget borrowings:

The off-budget debt was subjected to strict oversight after the Centre noticed many states were taking loans through their institutions, which was resulting in an incorrect assessment of their finances.

The Centra had noticed in FY22 that such off-budget borrowings would be considered as borrowings made by the state itself for the purpose of the Centre issuing its consent under Article 293(3) of the Constitution of India.
The Centre has also cleaned up its own off-budget borrowings by repaying loans such as those taken by the Food Corporation of India.

However, following the protests from several states, the Centre allowed four years till March 2026 to adjust their accumulated off-budget borrowings.

Interest free Long-term loans for Capex:

Union budget 2023-24 has proposed to continue with the 50-year interest-free loan to state governments that aid infrastructure investment. Most of it would be at the discretion of states, while parts of the expenditure will also be linked to conditions like

Scrapping old government vehicles
Urban planning reforms
Financing reforms in urban local bodies to make them creditworthy for municipal bonds
Constructing unity malls would focus on the sale of handicrafts, ‘one district, one product’ items, and GI products.

Besides, a part has to be directed at creating libraries as well as digital infrastructure, among others.