6.0

1999-20002000-012001-022002-032003-042004-05

2005-06 re

Trends in States’ Receipts

Trends in States’ Revenue Expenditures2

On the other hand, the revenue deficit of states, expressed as ratio to GDP, sharply fell from 2.9 per cent in 1999-2000 to just

0.5 per cent in 2005-06 (Figure 5). In other words, the decline in the revenue deficit has been achieved by the states by not spending the increasing revenue receipts and capital receipts. This conclusion becomes evident from the changes in the ratio of revenue expenditure to revenue receipts of states: this ratio fell continuously from 1.3 in 1999-2000 to 1.0 in 2005-06.

Data at the state-level also show stagnation, if not a fall, in the size of revenue expenditure relative to the size of the economy (Table 6). In Table 6, we have plotted the change (in percentage points) in the ratio of revenue expenditure to GSDP (of the corresponding states) between 2004-05 and three earlier years

Table 3: Selected Features of the Pattern of Revenue Receiptsof State Governments, 1990-91 to 2005-06

(As percentage of GDP at current market prices)

Year As a Ratio to GDP at Current Market Prices

Total Revenue Total Own Own Tax Own Non-tax Receipts Receipts Receipts Receipts

1990-91 11.6 6.9 5.3 1.6 1991-92 12.2 7.3 5.4 1.9 1992-93 12.0 7.0 5.3 1.7 1993-94 12.1 7.1 5.3 1.8 1994-95 11.9 7.6 5.4 2.1 1995-96 11.4 7.2 5.3 1.9 1996-97 11.0 6.8 5.1 1.7 1997-98 11.1 6.9 5.3 1.6 1998-99 10.0 6.4 5.1 1.4 1999-00 10.6 6.8 5.2 1.5 2000-01 11.3 7.1 5.6 1.5 2001-02 11.2 7.0 5.6 1.4 2002-03 11.4 7.3 5.8 1.5 2003-04 11.2 7.1 5.7 1.3 2004-05 11.9 7.6 6.1 1.5 2005-06 RE 12.9 7.7 6.4 1.3

Table 4: Selected Features of the Pattern of Capital Receipts ofState Governments, 1990-91 to 2005-06

(As a percentage of GDP at current market prices)

Year As a Ratio to GDP at Current Market Prices

Capital Receipts Special Securities Share of NSSF Issued to NSSF Loans in Capital Receipts

1990-91 4.3 – – 1991-92 4.1 – – 1992-93 4.0 – – 1993-94 3.3 – – 1994-95 4.3 – – 1995-96 3.6 – – 1996-97 3.1 – – 1997-98 3.9 – – 1998-99 4.9 – – 1999-00 5.3 1.3 25.5 2000-01 5.3 1.5 29.2 2001-02 5.2 1.6 30.2 2002-03 5.9 2.1 36.1 2003-04 na 2.4 na 2004-05 6.7 2.4 39.3 2005-06 RE 4.6 2.1 45.6

Figure 3: Average Rates of Interest on the Liabilities of the Centre and All States, 1980 to 2004

(Per cent per annum) 12

10 8 6 4 2 0 Rate of Interest (Per cent)

1980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004

Centre

States

Ch d kh dGh h(2005 )

Source:Chandrasekhar and Ghosh (2005a).

(2000-01, 2001-02 and 2002-03) for 19 states. What we see is a general decline in the ratio of revenue expenditure to GSDP in the states. In fact, between 2002-03 and 2004-05, there was a decline in the ratio of revenue expenditure to GSDP in 14 out of the 19 states considered.

The overall stagnation, if not decline, in the ratio of revenue expenditure to GSDP of state governments cannot be the result of lack of “absorption capacity” of states, as the finance ministry has argued. states like Haryana, Karnataka, Gujarat and Tamil Nadu, which have been characterised by many as fiscally “better managed”, have also exhibited an overall falling trend. There are, of course, many state-specific factors that would have to be considered, but a factor common to almost all the state governments is the compulsion, set by the FRBM Acts, to eliminate revenue deficits by 2008-09. A discussion on the FRBM Acts and their implications for expenditure of states is attempted in the next section.

II FRBM Acts and Expenditure Contraction

The FRBM Acts were the neo-liberal response to the fiscal crisis of the state in the latter part of the 1990s. The roots of the crisis in state finances in India have to be traced to the postindependence evolution of centre-state economic relations. Nevertheless, the present deterioration in state finances began in the mid-1980s when states as a whole started recording revenue deficits. This period also marked the end of the era of low and administered interest rates. The interest rates sharply increased thereafter, but as Chaudhuri (2000) has pointed out, its impact was masked by the presence of pre-existing cheap debt that the states had availed. From the latter half of the 1990s, the high cost debts incurred since the mid-1980s took their toll on the interest burden of states and started a process of debt escalation. The earlier policy of the cancellation of part of states’ debts by finance commissions was given up by then. The severe imbalance

Year Difference between states and centre

in state finances in 1980s and 1990s has been the topic for many scholarly enquiries [Bagchi, Bajaj and Byrd 1992; Rao 1992; Kurian 1999; Chaudhuri 2000; Vithal and Sastry 2001; Rao 2002; EPWRF 2004].

The role of the central government was critical in the process of deterioration of state finances. The rates of interest on borrowings of states were sharply increased after the mid-1980s, and especially so after 1990-91 (Table 7). The coupon rates of state government securities were raised sharply by the RBI from 1990-91 onwards. The weighted average of coupon rates, which was 11.5 per cent in 1990-91, reached its historic peak of 14 per cent in 1995-96. In the same period, the interest rates on small saving borrowings by states also increased from 13 per cent in 1990-91 to 14.5 per cent in 1992-93, and remained stable till 1997-98. These rates of interests that the states had to pay were

Year As a Ratio to GDP at Current Market Prices

1990-91 12.5 8.5 4.9 3.6 3.8 1991-92 13.0 8.9 4.7 4.2 4.0 1992-93 12.7 8.4 4.6 3.8 4.2 1993-94 12.6 8.2 4.5 3.7 4.3 1994-95 12.5 7.7 4.4 3.3 4.7 1995-96 12.1 7.4 4.5 3.0 4.5 1996-97 12.2 7.7 4.4 3.3 4.4 1997-98 12.1 7.4 4.4 3.0 4.5 1998-99 12.5 7.5 4.7 2.8 4.8 1999-00 13.3 7.7 4.9 2.8 5.4 2000-01 13.8 8.0 5.0 3.0 5.6 2001-02 13.8 7.6 4.7 2.9 6.0 2002-03 13.7 7.4 4.6 2.8 6.1 2003-04 13.4 7.4 4.3 3.1 6.0 2004-05 13.1 7.4 4.5 2.9 6.0 2005-06 RE 13.3 na na na na

Source: Indian Public Finance Statistics, Ministry of Finance, various issues; State Finances: A Study of Budgets, various issues, RBI (2006).

clearly usurious, much higher than the growth rate of the GDP and thus, a sure recipe for financial disaster. Even though the interest rates started falling thereafter, the financial burden that these periods of high rates of interest placed on state finances was significant. The interest payments of states increased from Rs 8,655 crore in 1990-91 to Rs 21,932 crore in 1995-96 and Rs 62,489 crore in 2001-02. As a percentage of total revenue receipts, these interest payments amounted to 13 per cent in 1990-91, 16 per cent in 1995-96 and 24 per cent in 2001-02.

In the period in which the centre was raising the rates of interest on states’ borrowings, the rates of interest on the centre’s borrowings were not only lower in levels, but were also rising at a much slower rate (Figure 3). The result was that the differential between the rates of interest faced by the centre and the states widened significantly in the 1990s, which has continued into the 2000s [Chandrasekhar and Ghosh 2005a; EPWRF 2004]. In fact, the differential in every year in the 2000s was higher than the differential for any year between 1980 and 2000. The average rate of interest of states’ borrowings was above 10 per cent even in 2004, while that of the centre had dipped below 7 per cent.

In 1997-98, there was another shock to state finances when the recommendations of the Fifth Pay Commission were implemented. This measure sharply raised the levels of revenue deficit of states from 1997-98 onwards. In just one year, the revenue deficit of states more than doubled – from 1.1 per cent in 199798 to 2.5 per cent in 1998-99. While we do not wish to neglect other factors, the rise in interest burden and higher salary payments constitute the two most prominent factors responsible for the deterioration of state finances. The outcome of these two factors was a sharp rise in the debt burden of states. As a percentage of GDP, the total debt outstanding of states increased from 21 per cent in March 1997 to 26.1 per cent in March 2000 and 33.1 per cent in March 2006 (Figure 4).

These changes are clearly visible when we analyse the long term trends in the levels of revenue deficit and fiscal deficit of all states (Figure 5). Through the 1970s, states as a whole were enjoying a revenue surplus. It was only by the late 1980s that the revenue account of states fell into deficit. The revenue deficit increased gradually between 1986-87 and 1997-98, and thereafter increased sharply till 1999-2000. Interestingly, the fiscal deficit of all states was rarely above 3 per cent till 1997-98. However, driven by the rise in the revenue deficit, the fiscal deficit of states rose sharply after 1997-98.

It was in this context that the FRBM Bill was introduced in the Parliament in 2000. The task force appointed by the government on the FRBM Act noted that

It was thus firmly believed in the neo-liberal circles, exemplified by the report of the task force, that “there is an innate synergy between acceleration of GDP growth and fiscal consolidation” (ibid). As the first step, the government appointed the E A S Sarma Committee to prepare a draft of the legislation; this committee submitted its report in July 2000. The FRBM Act was passed by the Lok Sabha on May 7, 2003 and by the Rajya Sabha on July 29, 2003. The bill was passed by a voice vote, and not unanimously, as the task force erroneously claimed. Members from the Left parties had raised their serious objections to the provisions in the Bill (see report in the People’s Democracy, 10 August 2003). The Bill was notified as an Act on August 26, 2003. In this version of the Act, the government had to eliminate the revenue deficit to zero by 2005-06. In July 2004, the Act was amended to postpone the year of elimination of revenue deficit to 2008-09. In February 2004, a task force was appointed by the government to “draw up the medium term framework for

Note: The last year of analysis is 2004-05, because 2004-05 was the latest year for which NSDP data were available.

Source: Indian Public Finance Statistics, Ministry of Finance, various issues; State Finances: A Study of Budgets, various issues, RBI (2006).

Source: EPWRF (2004), RBI (2005c); RBI (2005d); RBI (2006).

Figure 4: Total Outstanding Liabilities of All-Indian States, 1991 to 2006, as on End March

(as per cent of GDP)

Share in GDP (Per cent)

40 35 30 25 20 15 10 5 0

2 2 .5 2 2 .5 2 2 .5 21 . 9 21 .4 21 .1 21 .0 22 . 1 22 . 8 26 . 1 28 . 4 30 . 2 32 . 4 33 .4 33 .5 33 . 1 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Year

Source:RBI Bulletin; State Finances: A Study of State Budgets, RBI, various issues.

fiscal policies to achieve the FRBM objectives”, and “also formulate the annual targets indicating the path of adjustment and required policy measures” [GoI 2004: 201]. Introducing its projections on fiscal consolidation, the task force noted that “States finances would obtain an enormous boost under the proposals of this report” (ibid: 11).

Concurrently, the centre was also forcing the hands of the states to pass similar acts in their state assemblies. The finance commissions chose to have a narrow definition of “constitutional transfers” to mean only the divisible pool. The other grants and benefits were held to be over and above the “constitutional transfers” and thus could be tied to specific conditions. For the first time, the Eleventh Finance Commission started the process of linking resource transfers and other benefits from the centre to fiscal consolidation by states. The passage of the FRBM Acts at the state-level became an indicator of the progress achieved by states in fiscal consolidation. States were asked to model their legislations on the legislation prepared by the centre. Karnataka was the first to pass an FRBM Act in August 2002. Kerala, Tamil Nadu and Punjab followed suit in 2003. Uttar Pradesh passed its legislation in 2004. The other state governments, with the exception of a few, passed their FRBM Acts in 2005 and 2006. As on August 2006, 23 states had passed FRBM Acts [Ministry of Finance 2006].

The hurried passage of these legislations in 2005 and 2006 by many states had to do with the conditionalities put forward by the Twelfth Finance Commission (TFC). States had to pass the FRBM Act in 2005 itself to take advantage of the debt waiver scheme offered by the TFC. The main elements of the FRBM acts passed by the states were the following:

(a) 2 to 3 per cent target for fiscal deficit to be achieved by 2005-06 to 2010-11; (b) elimination of revenue deficit by around the same time; (c) limits to state government guarantees on debt;

(d) limits to overall liabilities that could be incurred; (e) formulation of a medium-term fiscal plan to reach these targets; and

(f) institution of a complaint redressal mechanism.

The specific point of our interest in this paper is the targets for revenue deficit, which are summarised in Table 8. The surprising rapidity with which FRBM Acts were passed by the states is an issue that requires some examination by political scientists. Vouching from the personal experience of one of the authors of this paper, most legislators in states knew pretty nothing about what they were passing. The legislature in Kerala, in a fit of reform fury, determined a 2 per cent ceiling for fiscal deficit by 2006-07. This was later de facto amended, but the fact that any political leadership could even propose a 2 per cent ceiling for fiscal deficit is indeed intriguing. The key players in this process were the bureaucracy of the state governments, who

Table 8: Year of Passing of State FRBM Acts and the Proposed Year of Elimination of Revenue Deficits

Year of Passage Proposed Year of Elimination of RD Other/Special of FRBM Act 2006 2007 2008 2009 2010 Cases

2002 Karnataka

2003 Kerala Tamil Nadu Punjab

2004 Uttar Pradesh

2005 Gujarat Orissa, Maharashtra, Assam Himachal Pradesh, Rajasthan, Haryana, Tripura Chhattisgarh, Madhya Pradesh, Andhra Pradesh

Note: Eight states passed their FRBM Acts in 2006, which are not shown in this table. Source: RBI (2005a).

Economic and Political Weekly December 2, 2006

Figure 5: Revenue Deficit and Fiscal Deficit of States, 1970-71 to 2005-06

(as per cent of GDP)

6.0

5.0

Deficit as share of GDP (per cent)

4.0

3.0

2.0

1.0

0.0 –1.0 –2.0

1970-711971-721972-731973-741974-751975-761976-771977-781978-791979-801980-811981-821982-831983-841984-851985-861986-871987-881988-891989-901990-911991-921992-931993-941994-951995-961996-971997-981998-991999-20002000-012001-022002-032003-042004-052005-06 re

Revenue deficit

Source:Ministry of Finance (2006); RBI (2006).

had so totally internalised the neoliberal reform rhetoric. How else could one explain the proposal of a 2 per cent ceiling for fiscal deficit?

The Role of Finance Commissions

There have been a number of criticisms of the Twelfth Finance Commission (TFC) exceeding its constitutional brief in proposing conditionalities on central transfers. The Constitution has defined the role of the finance commissions as to make recommendations on “the distribution between the union and the states of the net proceeds of taxes” and set “principles which should govern the grants-in-aid of the revenues of the states out of the Consolidated Fund of India”. In other words, the commissions were supposed to act as a neutral umpire to fix the levels of transfer of resources from the centre to states as well as the distribution of these transferred resources across states.

However, in recent years, extra-constitutional powers have been given to the finance commissions through the issue of additional terms of reference by the central government. These powers were provided to the commission in order to tune their reports to dovetail the policies of the central government. For instance, the terms of reference of the Eleventh Finance Commission (EFC) included the mandate to “draw a monitorable fiscal reforms programme aimed at reduction of revenue deficit of the states and recommend the manner in which grants to states…may be linked to progress in implementing this programme”. In fact, under Article 275 of the Constitution, the finance commissions have no powers to impose conditionalities on resource transfers to states. According to the report of the EFC, 15 per cent of the revenue deficit grants were explicitly linked to the progress achieved in the implementation of the fiscal reforms programme (that even included a forced reduction of subsidies and privatisation of the power sector).

The TFC had similar terms of reference, including the mandate to “review the state of the finances of the Union and the States and suggest a plan by which the governments, collectively and severally, may bring about a restructuring of the public finances

Year

Fiscal deficit

[by] restoring budgetary balance [and] achieving macro-economic stability and debt reduction along with equitable growth.” The TFC was also given powers to “review the Fiscal Reform Facility introduced by the Central Government on the basis of the recommendations of the Eleventh Finance Commission, and suggest measures for effective achievement of its objectives.”

The TFC recommended a fiscal restructuring plan in its report, according to which (a) the revenue deficit had to be eliminated by 2008-09; (b) the fiscal deficit had to be brought down to 3 per cent in 2008-09; and (c) annual targets were set for the reduction of revenue deficit and fiscal deficit (0.4 percentage points for the revenue deficit and 0.3 percentage points for the fiscal deficit for all states put together). Each state had to enact a fiscal responsibility legislation to this effect. The TFC, in order to address the rising debt burden of states, also recommended a general scheme of debt relief and a loan write-off scheme. As per the general scheme, all loans from the centre (excluding the high-cost loans under NSSF) were to be consolidated and a uniform interest of 7.5 per cent charged on them. Under the loan write-off scheme, repayments on loans from the centre between 2005-06 and 2009-10 were to be written-off, with the quantum of write-off linked to the absolute amount of reduction of revenue deficit of the state in each successive year as well as the containment of the fiscal deficit at the level of 2004-05. The benefits of both these schemes were to be made available to only those states that had passed fiscal responsibility legislations.

Such has been the environment generated by the neoliberal reformers that few states are willing to break the rules. The West Bengal government has refused to pass an FRBM Act. The present government in Kerala, in its revised budget for 2006-07, has declared that its FRBM Act would be amended. Nevertheless, as can be seen from Figure 5, state governments on the whole have been moving fast to meet the targets set by FRBM Acts and the TFC. The revenue deficit for all states has declined from

2.9 per cent of the GDP in 1999-2000 to 0.7 per cent of the GDP in 2005-06. As we have seen already, this contraction has been achieved mainly by cutting important social sector expenditures. The states are thus set to reach the target of elimination of revenue deficit by 2009. Same is the case with respect to the fiscal deficit; it declined from 4.7 per cent of the GDP in 1999-2000 to 3.2 per cent in 2005-06 (Figure 5).

Economists from the Left have been the most consistent critics of the central policies of framing legislations to cap revenue and fiscal deficits [Patnaik 2000, 2001; Chandrasekhar and Ghosh 2000, 2001, 2005a, b]. More recently, the Planning Commission also seems to have understood the implications of continuing with the FRBM Acts to any strategy to development that would involve acceleration of revenue expenditure. The Planning Commission, in its attempt to have “faster” but “more inclusive” growth in the Eleventh Five-Year Plan, has outlined a strategy that includes a number of new initiatives, such as the expansion of school education, programmes for provision of healthcare, drinking water, rural infrastructure and schemes for “bridging the divides”. All these ambitious programmes belong essentially to the revenuedevelopment expenditure category and cannot be implemented if the FRBM/TFC targets of elimination of revenue deficit are achieved. The entire strategy of the Eleventh Plan would collapse if revenue deficit is eliminated by 2008 or 2009.

The Planning Commission is draft approach paper also discusses the issue of fiscal deficit targets in the FRBM Acts. It says that important Plan expenditures, such as in infrastructure, may have to be postponed if the targets of fiscal deficit are adhered to. Such postponement, the paper argues, “could jeopardise growth” and could reduce the space available for “countercyclical fiscal measures” in times of economic slowdown. Again, as the approach paper reminds us, the state governments would have no option but to postpone capital investments as they have a double bind – apart from being forced by the FRBM Acts to cut fiscal deficits, they are also bound by the much stiffer targets set by the TFC that has linked such adjustments to resource transfers. As the centre is not bound by the TFC, it may avoid this situation either by postponing the achievement of targets or by modifying the central FRBM Act to remove the targets set.

Kerala is one of the states that is characterised by severe fiscal imbalance: its revenue deficit, fiscal deficit and public debt, as ratios to GSDP, have been significantly higher than the average for all Indian states. On the one hand, its expenditure pattern is characterised by a heavy commitment to recurring social services expenditure, as high priority has been accorded to social infrastructure historically. While social sector investment in Kerala has led to better health and longevity to its people, it has also resulted in a high burden of pension payments on the exchequer. In 2005-06, pension payments in Kerala constituted about 51 per cent of the total salary expenditure.

On the other hand, Kerala’s revenue potential is circumscribed by the relatively high ratio of exports among the taxable commodities and the domination of services in the GSDP. Further, the inappropriateness of the Finance Commission criteria for devolution, weightage and its indicators, have been responsible for the fall in the share of central taxes to the state over the years. The share of Kerala among all states in the central taxes declined from 3.9 per cent in the Tenth Finance Commission period to

3.1 per cent in the Eleventh Finance Commission period and to

2.7 per cent in the Twelfth Finance Commission [George et al 2006]. The widening non-plan revenue gap of the state has also not been addressed by the successive finance commissions. The relatively improved social indicators and the lower headcount ratio of poverty have reduced the state’s share in central sector schemes (CSS) to less than 1 per cent in 2005-06. Finally, the rise in the high-cost debt burden has resulted in the escalation of the interest charges in the disbursements of the state.

We do not wish to go into a more detailed analysis of the factors responsible for the fiscal imbalance of Kerala’s finances beyond the above summary [George 1999; George and Krishnakumar 2003; Kannan and Mohan 2003; Mohan and Shyjan 2005]. As can be seen from the data in Table 9, similar to the experience of most Indian states, the latter half of the 1990s saw a significant increase in the revenue deficit, fiscal deficit and the debt burden of the state. This trend assumed crisis proportions in 2000-01 when the revenue deficit increased to 4.5 per cent and the fiscal deficit increased to 5.6 per cent of the GSDP. The severe agrarian crisis that engulfed the state’s economy at the end of the 1990s (due to the sharp downturn in the prices of commercial crops) took a heavy toll on the state’s tax collection. The own tax GSDP ratio, which averaged 8.6 per cent in the second half of the 1990s declined to 8.4 per cent in 2000-01. It can also be seen that there was a sharp decline in the share of central transfers in the total revenue of the state from 32 per cent in the first half of the 1990s to 28.1 per cent in the second half of the 1990s and further to

25.2 in 2000-01. The unexpected decline in the central devolution, primarily as a result of the lower share in the central transfers awarded by the Eleventh Finance Commission, left a gap of more than Rs 500 crore in the budget of 2000-01. As a result, the total revenue receipts, as a share of GSDP, declined to 12.5 per cent in 2000-01 from 13.4 per cent in the period 1995-96 to 1999-2000.

On the expenditure side, the implementation of the Pay Equalisation Committee recommendations increased the salary payments by over Rs 1,000 crore per annum. There occurred a very severe crisis of Overdraft in 2001, and even the closure of the treasury. The substantial devolution of funds to the local selfgovernments and the consequent spurt in the number of treasury cheques in circulation issued by the LSGIs to thousands of beneficiaries made the crisis highly visible and vulnerable. This fiscal crisis was an important factor, among others, that contributed to the defeat of the LDF in the 2001 assembly elections.

The UDF government that came to power in 2001 brought out a white paper that sought a dramatic exaggeration of the fiscal crisis of the state government so as to prepare ground for a drastic fiscal adjustment programme [GoK 2001]. The remedial measures to deal with the so-called impending disaster included expenditure compression (such as curtailment of benefits to employees and reduction in social subsidies, including welfare pensions), closure of sick public sector undertakings and all-round increases in user charges. These prescriptions became the conditionalities in the semi-structural adjustment loan that the state government took from the Asian Development Bank (ADB). These were further reinforced by the Fiscal Responsibility Act 2003, which set the goal to wipe out the revenue deficit and reduce the fiscal deficit to 2 per cent of the GSDP by 2006-07. The government guarantees for liabilities were capped at an absolute figure of Rs 14,000 crore. Meeting the above targets would have required draconian measures, which even the UDF government found politically and socially difficult to carry out. The move to curtail government employees’ benefits and rights met with stiff resistance including a month-long strike. A major “Save-PSU” movement emerged and numerous agitations by the workers in the traditional sector took place. There was also a mass movement against privatisation policies in the educational and health sectors.

Between 2000-01 and 2001-02, the revenue expenditure of the state declined sharply from 17 per cent to 16.1 per cent of the GSDP and the revenue deficit of the state declined from 4.5 per cent to 3.6 per cent of the GSDP (Table 9). The fiscal deficit of the state also declined from 5.6 per cent to 4.5 per cent of the GSDP between 2000-01 and 2001-02. However, the ratios were reversed in the very next year. The state government, in its memorandum to the TFC in 2003, admitted that the “shortterm measures, such as expenditure compression and postponement of liabilities, are bound to show up as expenditure in the following years” [GoK 2003: 14]. But the government hoped that “the medium-term measures are expected to bring in the fiscal sustainability” (ibid).

IV Summing Up

Public expenditure by states on social and economic services, a crucial necessity for fulfilling the basic needs of people, is low in India by any standard and needs urgent enhancement. However, in the 1990s and 2000s, the ratio of revenue expenditure by all states to the GDP has stagnated, if not declined. At the same time, all states together have an investment outstanding of over Rs 64,000 crore in the treasury bills of the centre. Then why do the states not spend this money? The union finance minister has concurred in the Parliament that much more needs to be invested in education, health care, the mid-day meal scheme, rural roads and urban development. The problem, according to him, is that states are “unable to spend” because they do not have the “absorptive capacity”. Our position in this paper has been that this is a false and misleading argument.

States do not spend because there are legal constraints on spending. The finance ministry and the successive finance commissions have forced the states to pass fiscal responsibility legislations in their assemblies. As per these legislations, states have to eliminate the revenue deficit and reduce the fiscal deficit to 3 per cent of the GSDP by 2008-09. In line with these targets, the revenue deficit and fiscal deficit of states declined sharply in the 2000s. This decline in revenue deficit was achieved by keeping the revenue expenditure to GDP ratio stagnant, even while there was an increase in revenue receipts to GDP ratio of states. The states could have raised revenue expenditures by making use of the increased receipts, and still kept the revenue deficit constant. This, however, would have been contrary to the targets set for the elimination of revenue deficit by 2008-09. Even the increased capital receipts – in the form of NSSF borrowings

– were not routed to revenue expenditures because of the fear of rising revenue deficit. The cash surplus phenomenon, thus, is a perverse outcome of the FRBM Acts.

The case study of Kerala in this paper sharply brings out the adverse implications of mechanically designed fiscal adjustment programmes in the context of long-term commitments to social spending and exogenous changes like pay revisions. Going by the provisions of the FRBM Act, Kerala would have to sharply cut plan expenditures, reduce social spending and curtail devolution to local self-governments.

The Planning Commission has already taken a position against the lack of flexibility in the FRBM Act provisions. Demands for more flexibility are also fully endorsed by international experiences with fiscal responsibility legislations. As we have argued, the FRBM Act has to go off the rule book or drastically amended. This demand is today in the centre stage of centre-state relations in India.

lli

Email: tisaaq@gmail.comrr@tiss.edu