Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources.
Key Phrases: Tax revenue, Committed expenditure, Rising subsidy, Fiscal conditions, Reserve Bank of India, Debt/ GSDP ratio, Interest payment to revenue receipts, 15th Finance Commission, Ujwal DISCOM Assurance Yojana.
Why in News?
- Slowdown in tax revenue, a high share of committed expenditure and rising subsidy burden have stretched State government finances.
Context:
- The fiscal conditions among states in India are showing warning signs of building stress.
- As per Reserve Bank of India, Bihar, Kerala, Punjab, Rajasthan, and West Bengal as highly distressed States among 10 States with the highest debt burden, going by the debt/ GSDP ratio.
- For the five most indebted States, the debt stock is no longer sustainable, as the debt growth has outpaced their GSDP growth in the last five years.
Fiscal Condition of Various States:
- Stress tests show that the fiscal conditions of the most indebted State governments are expected to deteriorate further, with their debt-GSDP ratio likely to remain above 35 per cent in 2026-27.
- Based on the debt-GSDP ratio in 2020-21, Punjab, Rajasthan, Kerala, West Bengal, Bihar, Andhra Pradesh, Jharkhand, Madhya Pradesh, Uttar Pradesh and Haryana turn out to be the states with the highest debt burden.
- These 10 States account for around half of the total expenditure by all State governments in India. Other vulnerability indicators also capture these 10 States in their cross hairs.
- Their GFD-GSDP ratios were equal to or more than 3 per cent in 2021-22, besides deficits in their revenue accounts (except Uttar Pradesh and Jharkhand).
- Moreover, the Interest Payment to Revenue Receipts (IP-RR) ratio, a measure of debt servicing burden on States’ revenues, in 8 of these States was more than 10 per cent.
- Among the 10 States, Andhra Pradesh, Bihar, Rajasthan and Punjab exceeded both debt and fiscal deficit targets for 2020-21 set by the 15th Finance Commission (FC-XV).
- Kerala, Jharkhand and West Bengal exceeded the debt target, while Madhya Pradesh overshot the fiscal deficit target. Haryana and Uttar Pradesh were exceptions as they met both criteria.
- Rajasthan, Kerala and West Bengal are projected to surpass the FC-XV targets for debt and fiscal deficit in 2022-23 (Budget Eestimate/BE).
Do you know?
- Revenue expenditure refers to the expenditure that neither creates an asset nor reduces the liability of the government. They are regular and recurring; Short-term; Example-Payment of salaries, maintenance of roads, street lights, etc.
- Capital expenditure refers to the expenditure that either creates an asset or reduces the liability of the government. They are irregular and non-recurring; Long-term; Example- Construction of metros, dams etc., repayment of loans to IMF etc., purchase of machinery, etc.
- Monetary policy is concerned with the management of interest rates and the total supply of money in circulation. It is generally carried out by the RBI.
- Fiscal policy estimates taxation and government spending. It should ideally be in line with the monetary policy, but since it is created by lawmakers, people's interest often takes precedence over growth.
- Fiscal Responsibility and Budget Management (FRBM) Act was
enacted in 2003. The objective of the Act is
- to ensure inter-generational equity in fiscal management;
- long-run macroeconomic stability;
- better coordination between fiscal and monetary policy and
- transparency in the fiscal operations of the Government.
- It became effective from July 5, 2004.
- The FRBM Act of the Centre was amended in 2018 to set a ceiling on general government debt at 60% of GDP by 2024-25 (with 40% limit on the Centre’s debt).
Neglect of FRBM Act
- The Fiscal Responsibility and Budget Management (FRBM) Act lays
down the ceiling for debt to GSDP ratio for States at 25%.
- Whereas, 8 of the 15 States exceeded the limit in FY22 with States such as Punjab, Rajasthan and Bihar far above the mandated level.
- FRBM committee had recommended that the combined debt of States should
reduce to 20% of GDP by 2023,
- Whereas, State debt is set to exceed 33.5 % of GDP by the end of FY23 (as per SBI Research).
Reasons for high Debt/GSDP ratio of State:
- On a general level, the Covid-19 pandemic is seen as the primary reason for a surge in debt levels of Indian States. However, the slowdown in economic activity had begun in 2018-19, nearly two years before the pandemic hit.
- There was a decline in States’ own tax revenues, which led to them borrowing more in order to finance their scheduled spending.
- Another factor said to be responsible for the poor financial health of State governments is Centre’s Ujwal DISCOM Assurance Yojana (UDAY) scheme, which allowed the state governments that own power distribution companies to take over 75 per cent of these companies’ debt, and pay back the lenders by selling bonds.
- However, State-specific factors have also resulted in declining
finances. like
- Relaunch of the old pension scheme by some States.
- Rising expenditure on non-merit freebies.
- Expanding contingent liabilities.
- Punjab and Uttar Pradesh — both States that recently went to polls — announced populist schemes with such unsustainable debt, making matters worse. Take Punjab, for instance. Before the Aam Aadmi Party (AAP) won the elections, it promised the people 300 units of free electricity a month for every household. In addition, it promised Rs 1,000 a month to every woman in the State.
15th Finance Commission
The Finance Commission is a constitutional body formed by the President of India to give suggestions on centre-state financial relations. The 15th Finance Commission was chaired by Mr. N. K. Singh. Key recommendations in the report on fiscal roadmap for 2021-26 include:
- Fiscal deficit and debt levels: The Commission suggested that
the Centre bring down fiscal deficit to 4% of GDP by 2025-26. For
States, it recommended the fiscal deficit limit (as % of GSDP) of:
- 4% in 2021-22
- 3.5% in 2022-23
- 3% during 2023-26.
- If a State is unable to fully utilise the sanctioned borrowing limit as specified above during the first four years (2021-25), it can avail the unutilised borrowing amount (calculated in rupees) in subsequent years (within the 2021-26 period).
- Extra annual borrowing worth 0.5% of GSDP will be allowed to
States during first four years (2021-25) upon undertaking power
sector reforms including:
- Reduction in operational losses
- Reduction in revenue gap
- Reduction in payment of cash subsidy by adopting direct benefit transfer
- Reduction in tariff subsidy as a percentage of revenue.
- The Commission recommended path for fiscal deficit for the Centre
and States for result in a reduction of total liabilities of:
- The centre from 62.9% of GDP in 2020-21 to 56.6% in 2025-26
- The states on aggregate from 33.1% of GDP in 2020-21 to 32.5% by 2025-26.
- It recommended forming a high-powered inter-governmental
group to
- Review the Fiscal Responsibility and Budget Management Act (FRBM)
- Recommend a new FRBM framework for Centre as well as States, and oversee its implementation.
Measures for fiscal consolidation of States:
RBI suggested various corrective measures for fiscal consolidation of States. This includes the following:
- Restrict their revenue expenses by cutting down expenditure on non-merit goods in the near term.
- In the medium term, the States need to put efforts towards stabilising debt levels.
- It also recommended large scale reforms in power distribution sector would enable the Discoms (power distribution companies) to reduce losses and make them financially sustainable and operationally efficient.
- In the long term, increasing the share of capital outlays in the total expenditure will help create long-term assets, generate revenue and boost operational efficiency.
- State governments need to conduct fiscal risk analyses and stress test their debt profiles regularly to be able to put in place provisioning and other specific risk mitigation strategies to manage fiscal risks efficiently.
- Efficiency in public spending should now become part of discussions. This can happen through tax-benefit models that look at how State resources can be best utilised.
- There is also a need to establish outcome documents that will keep the State spending in check.
Way Forward:
- There has to be a differentiated approach for different States. The policy, for example, for Gujarat cannot be the same as for West Bengal because the starting conditions are different and their political economy is different. So different states cannot shrink their debt-to-GSDP ratio at the same speed.
- There is a need for some kind of fiscal council or interstate mechanism that can ensure that FRBM limits on spending are strictly adhered to, along with ensuring the quality of expenditure of the States.
Source: The Hindu BL
Mains Question:
Q. Discuss the reasons behind the high Debt/GSDP ratio of State and suggest measures for fiscal consolidation in the States.
