In India, states raise more than a third of total revenue, account for 60% of combined government expenditure, and account for about 40% of government borrowing. Given the size of states’ fiscal operations, an updated understanding of their finances is critical for drawing evidence-based conclusions on the country’s fiscal position – in brief, analysis of the emerging fiscal position of states from individual state budgets for 2023-24 By examining key data on the finances of.
Fiscal Imbalance and Consolidation
As we near the end of the first quarter of FY 2023-24, it is becoming clear that the normal government deficit and debt growth witnessed during the COVID-19 pandemic is beginning to abate. Significant financial reforms have taken place at the central and state levels after the pandemic. At the Union level, fiscal deficit to come down from 9.1% of GDP in 2020-21 to 5.9% in 2023-24 (BE). The fiscal deficit of all states in 2020-21 was 4.1% of GDP. This has come down to 3.24% of GDP in 2022-23 (RE). For major states, for the year 2023-24 (BE), it is expected to be 2.9% of GDP.
This sharp reduction in fiscal deficit shows that we cannot take an effective view of the fiscal position of the country, especially the states. Due to the lack 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. Compiling fiscal data from individual state budgets is difficult and time-consuming. Therefore, the timeline for this publication by RBI is during the second half of the financial year.
The analysis here is based on data collected from individual budgets of 17 major states. These states account for more than 90% of the combined expenditure of all states. Thus, the fiscal issues emanating from his budget represent the state’s finances in India. The analysis shows that these states together have been able to control their fiscal deficit. This fiscal consolidation is significant in several ways. First, overall the states managed to be fiscally prudent even during the peak of COVID-19 despite significant contraction in revenue. Second, emergency provisioning for health expenditure and livelihoods during the COVID-19 pandemic was not easy and required centre-state financial coordination. Third, the states were able to re-prioritise expenditure and bring the fiscal deficit under control quickly. Fourth, the reduction in fiscal deficit is a combination of higher tax devolution due to expenditure-side adjustments, better Goods and Services Tax (GST) collections and a buoyancy in central revenues. Fifth, non-GST revenue is also showing signs of recovery in most states post the pandemic.
fiscal challenges
However, there are some significant fiscal challenges that need to be addressed in the short to medium time frame – the most important being controlling the revenue deficit of states. Along with the reduction in the fiscal deficit, there has not been a reduction in the revenue deficit as well. In 2023-24 (BE), 13 out of 17 major states have a deficit on the revenue account. Of the 13 states, seven states have fiscal deficits primarily driven by revenue deficits; These states are Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu and West Bengal. They also have a huge debt to GSDP ratio.
It is true that mere existence of revenue deficit cannot be considered as a sign of fiscal waste. It is also true that the pressure on revenue expenditure was high during the Covid-19 pandemic. A more detailed and careful analysis of the increase in the revenue deficit of the states is also necessary. However, the rising revenue deficit leading to fiscal imbalance has long-term fiscal implications and this imbalance in the revenue account needs to be corrected.
For these seven states, their specific shares of revenue deficit to 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 share of all states in the revenue deficit is expected to be 27% in the fiscal deficit in the same year.
Assessments by successive Finance Commissions since the Twelfth Finance Commission identified three states, namely Kerala, Punjab and West Bengal, as fiscally stressed states. Now the number of fiscally stressed states has increased to seven (as measured in terms of revenue deficit levels).
What does this mean for general government macroeconomic stability? This can be gauged when the following fiscal figures are considered: the combined fiscal deficit of these states is 3.71% of GSDP, as against the all-state average of 2.9%; Their combined revenue deficit is 2.15% of GSDP, while the revenue deficit of all states is 0.78%; Their combined debt ratio is higher than the debt ratio recommended by the Finance Commission for all states for the year 2023-24. These states together contribute about 40% to India’s GDP. In this context, to ensure high state-specific growth, fiscal stability of state finances is critical. Some of these states have also been major drivers of public capital expenditure and preferred investment destinations for private investors.
Revenue Deficit Consolidation Framework
A long-term perspective is also necessary on the question of revenue deficit. If we check the data of the last 20 years, before COVID-19 the revenue deficit from the state budget had almost disappeared. Overall, the states were generating revenue surplus in almost all the years during this period. However, with the re-emergence of revenue deficit in recent years, the focus should be on managing the revenue deficit by creating an incentive compatible framework. The following measures may be considered.
Going forward, if interest-free loans to states are continued by the central government, this can be linked to a reduction in the revenue deficit. This will help in eliminating the possibility of substitution of States’ own capital expenditure and also prevent diversion of borrowed resources to finance revenue expenditure. A defined time path for revenue deficit reduction with a credible fiscal adjustment plan will help restore fiscal balance and improve the quality of expenditure.
Future-oriented performance incentive grants may also be considered to reduce the revenue deficit. In this context, various approaches provided by earlier Finance Commissions may be considered for designing the incentive structure.
In conclusion, we need to re-focus on managing the revenue deficit. Macro view is necessary for this.
Pinaki Chakraborty is an economist and former director of the National Institute of Public Finance and Policy, New Delhi. E-mail:pinakicha@gmail.com