ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

A+| A| A-

Indian States' Fiscal Correction: An Unfinished Agenda

More than half of the 14 major states achieved significant fiscal correction during 2000-06, with Karnataka, Tamil Nadu, Orissa and Haryana in the lead. However, some high and middle income states lag behind, continuing to accumulate unsustainably high levels of debt and guarantees. The majority of states have relied more on enhancing their own revenues than on contracting expenditures, which is welcome in the context of the squeeze on infrastructure and social service expenditures that states had experienced over the 1990s. Those that have committed to fiscal responsibility and have achieved significant correction now face the challenge of translating outlays to outcomes. Those that lag behind must first address the challenge of fiscal discipline, learning from the success of others. It would be advisable to target the end-of-year stock of outstanding debt and guarantees, in addition to current account balance ("golden rule"). Monitoring of end-of-year stock rather than annual flows would enhance year-to-year flexibility in states' fiscal management, while remaining within an agreed correction path.

SPECIAL ARTICLE

Indian States’ Fiscal Correction: An Unfinished Agenda

V J Ravishankar, Farah Zahir, Neha Kaul

More than half of the 14 major states achieved significant fiscal correction during 2000-06, with Karnataka, Tamil Nadu, Orissa and Haryana in the lead. However, some high and middle income states lag behind, continuing to accumulate unsustainably high levels of debt and guarantees. The majority of states have relied more on enhancing their own revenues than on contracting expenditures, which is welcome in the context of the squeeze on infrastructure and social service expenditures that states had experienced over the 1990s. Those that have committed to fiscal responsibility and have achieved significant correction now face the challenge of translating outlays to outcomes. Those that lag behind must first address the challenge of fiscal discipline, learning from the success of others. It would be advisable to target the end-of-year stock of outstanding debt and guarantees, in addition to current account balance (“golden rule”). Monitoring of end-of-year stock rather than annual flows would enhance year-to-year flexibility in states’ fiscal management, while remaining within an agreed correction path.

The authors would like to acknowledge the guidance and substantive comments on a working draft of the paper received from V S Senthil, department of expenditure, ministry of finance. The opinions expressed in this paper are those of the authors and not to be interpreted as the opinion of the World Bank.

V Ravishankar (Vravishankar@worldbank.org

)
, Farah Zahir (Fzahir@worldbank.org) and Neha Kaul (Nkaul@ifc.org) are with the World Bank and are based in New Delhi.

Economic & Political Weekly

EPW
september 20, 2008

I
n its positive assessment of state finance in 2006-07, the Reserve Bank of India (2006) had highlighted that the fiscal deficit1 of all states, taken together, declined from 4.7 per cent of Gross Domestic Product (GDP) in 1999-2000 to an estimated 3.2 per cent in 2005-06.2 Their deficit on current account, called the revenue deficit, declined from 2.7 per cent to 0.5 per cent of GDP. A close examination of state specific performance reveals that poorer and fiscally more dependent states have, in general, achieved stronger fiscal correction than the high income states. Traditionally strong and leading states such as Maharashtra, Gujarat and Punjab have lagged behind in fiscal correction. Even after enacting fiscal responsibility legislation, they continue to accumulate unsustainably high levels of debt and guarantees.

1 Introduction

Fiscal performance by Indian states during 2000-06 is to be seen in the context of the historical backdrop of the 1990s, a decade characterised by serious deterioration in state finances, and ending with a fiscal crisis [World Bank 2005]. At the turn of the century, the states were experiencing unsustainable debt trends and a squeeze on resources available for essential infrastructure and social services for which they have primary responsibility under the Constitution – including policing, public health, school education, road connectivity, irrigation and drinking water supply. The fiscal improvement during 2000-06 is a result of three underlying factors, namely: (i) fiscal correction efforts by the majority of states, (ii) rise in the share of central resources, especially to the poorer states, resulting from the awards of the Eleventh and Twelfth Finance Commissions; and (iii) acceleration of economic growth in India since 2003-04.

This paper pays attention to three dimensions, or criteria, of fiscal correction at the state level: (a) the “golden rule”, or achievement and sustenance of current account balance; (b) debt sustainability, to be pursued by achieving and maintaining a primary fiscal surplus (primary balance = revenue receipts – non-interest expenditure) and by controlling guarantees; and (c) state’s own revenue effort, which is one indicator of the quality of fiscal adjustment. A state that does weakly in its revenue effort, relying mainly on expenditure cuts to reduce its deficit, is to be judged as having performed poorer than one that does strongly on own tax effort and reduces its deficit mainly on the revenue side, or through a combination of revenue and expenditure measures.

Section 2 examines the sources of correction in the primary fiscal deficit. Section 3 explains each of the three criteria and lays out the combined measure of the strength of fiscal correction by

SPECIAL ARTICLE

states during 2000-06. Section 4 summarises some key lessons for the states, going forward. Section 5 presents the main lessons for the centre.

2 Sources of Fiscal Correction

The primary (non-interest) fiscal deficit of states has declined during 2000-06 largely on account of (i) increase in central resource transfers, and (ii) states’ own correction. The states’ own effort can in turn be further decomposed into (a) increase in own revenues, and (b) contraction in non-interest expenditure.

The majority of states have relied mainly on enhancing their own tax revenues to reduce deficits, rather than contracting

Figure 1: Resources and Deficits (2000-06, % of GSDP per year) Central resources

2.00

1.50

1.00

0.50

0.00

-0.50

-1.00

States’ own resources Contraction of non-interest expenditure Primary correction

-1.50 -MH MP AP PJ KN BH HY UP KR TN GJ RJ WB OR

expenditures (Figure 1). The largest reduction in primary deficit during 1999-2006 has been achieved in Orissa, with significantly larger state’s own effort as compared to enhanced central resources. Orissa also stands out as the only state that has gained significantly from both revenue enhancement and expenditure contraction, in addition to enhanced central transfers.

A state like Bihar, on the other hand, shows moderate improvement in the primary deficit despite a huge increase in central transfers. This is because it showed a significant increase in noninterest expenditure. Along with Gujarat it is the only state to have registered a decline in own resources over this period. Karnataka shows the highest increase in own revenues among all states but it is also the only state to show a decline in central transfers. This method of fiscal adjustment through fiscal empowerment (larger dependence on own resources) adopted by Karnataka is the most sustainable form of correction as it reduces any vulnerabilities arising from high dependence on central resources.

There are several factors that have contributed to the rise in the level of the states’ own revenues. First, sales tax rates were rationalised through an inter-state agreement in 1999-2000, leading to the adoption of uniform bands for different categories of commodities. Second, the fiscal crisis at the end of the 1990s prompted a number of states to focus on tightening tax administration and strengthening their tax efforts, supported by policylinked external assistance in some cases. Third, acceleration of economic growth, starting in 2003-04, led to an expansion in the base for sales tax, liquor excise and stamp duties on real estate transactions. Fourth, the introduction of Value Added Tax (VAT) by the majority of states in 2005, replacing the single-point sales tax, led to a further expansion in the tax base. Non-tax revenues, which include user charges and mineral royalties, have remained stagnant or declined as share of Gross State Domestic Product (GSDP) in most cases. This reflects political resistance to raising user charges for public services provided by

58 the state governments, as well as the reluctance of the government of India to adjust mineral royalty rates upwards.3

A comparison of the level of own revenues among the states, including both tax and non-tax revenue, is shown in Figure 2. The southern states of Karnataka and Tamil Nadu which are middle-income states, and the northern high income states of Punjab and Haryana, are the four with the highest relative tax take in 2005-06; and except for Punjab, the other three have maintained or improved their ranking since 1998-2000. Among the poor states, those that have significantly increased their own revenues (by more than 2 percentage points of GSDP since 1998-2000) are Orissa, Uttar Pradesh, Rajasthan and Madhya Pradesh. Those that have consistently remained at the bottom of the ladder are Bihar and West Bengal. Those that have slipped in their ranking are Gujarat, Kerala, Maharashtra and Punjab (refer to Table A1 (p 62) in the annex for details).

The process of revenue augmentation is being further aided by the recommendations of the Twelfth Finance Commission (TWFC) which include the following: (i) Increase in share of states in the central tax kitty from 29.5 per cent to 30.5 per cent with the share of poor states increasing more than proportionately,

(ii) Higher special purpose grants especially to poorer states. The average annual grant for all states has increased by 143 per cent between the Eleventh and Twelfth Finance Commissions.

Only a couple among

Figure 2: States’ Own Revenue Growth

the major states have cor-(2000-06, Own Revenue (% GSDP)) rected mainly through ex-Gujarat penditure contraction, viz, Bihar

1998-2000

Gujarat and West Bengal

West Bengal

2005-06

(Figure 1). A high income

Kerala

state like Gujarat has ac-

Maharashtra

tually lost 2.5 percentage

Andhra Pradesh

points in tax effort since the mid-1980s. The earth-

Madhya Pradesh

quake of 2001 could only Uttar Pradesh partially account for

Tamil Nadu

Gujarat’s dismal perform-

Rajasthan

ance during 1999-2005.

Haryana

On closer look one ob-

Orissa

serves that sales tax reve-

Punjab

nues had started falling in Gujarat post 1995. One of Karnataka

ı ı ı ı ı ı ı ı ı ıthe many reasons that 0 2 4 6 8 10 12 14 16 18 have been associated with low revenue productivity of the sales tax revenues is the exemptions, tax deferment and tax holidays to the business community. Gujarat in its efforts to attract investment has been giving tax sops to businessmen. Govinda M Rao (2002), points out that the principal reason for the deceleration in the growth rate of sales tax has to be found in the inability to extend the base to the services sector. Since about 40 per cent of Gujarat’s income is coming from the services sector, it is possible that a large part of the economy is not in the tax net.4 Contraction in non-interest current expenditure is being achieved by maintaining only a moderate growth in the salary bill (which is relatively very low in Gujarat, reflecting a leaner government to begin with) and by some reduction

september 20, 2008

SPECIAL ARTICLE

in subsidies to the state-owned utilities, especially in the power sector. However, the overall commitment to a hard budget constraint is not so strong in Gujarat, as evidenced by high and rising level of outstanding debt and guarantees (see below).

Table 1: Debt and Guarantees as Per Cent of Revenue

Debt/Revenue (Debt + Guar)/Rev
1998-01 2004-05 2005-06 1998-01 2004-05
Andhra Pradesh 175 235 208 249 296
Bihar 255 293 257 264 300
Gujarat 178 309 278 266 386
Haryana 215 209 203 313 248
Karnataka 144 157 163 218 222
Kerala 249 314 292 331 405
Madhya Pradesh 165 206 210 225 253
Maharashtra 159 221 208 257 364
Orissa 313 290 254 369 322
Punjab 354 338 285 462 415
Rajasthan 253 320 302 348 392
Tamil Nadu 148 178 172 201 205
Uttar Pradesh 272 289 255 303 311
West Bengal 319 478 423 359 549

Source for all statistical Tables is RBI State Finance Bulletin various years, CSO, State Budget Documents, Staff Estimates.

In the middle income category, West Bengal has been the worst performer because of poor tax compliance and administration, lack of willingness to check evaders or to tax agricultural incomes. The case of West Bengal is worrisome, both because of a continuing high debt level and a low a level of developmental expenditure. Its capital spending budget and human development outcomes were low to start with, and expenditure cutbacks have had a negative impact on both current and capital spending, giving the impression that it is probably an across-the-board cut in non-wage expenditures, with a negative impact on development.

Of the three components of committed or relatively inflexible expenditure, namely, salaries, pension and interest payments, the one that is most directly under the control of the states is the contractual employees instead of regular staff, including parateachers for public elementary schools.

The largest subsidies at the state level in India are entirely or partly implicit in nature. Canal irrigation is provided at subsidised rates to farmers. The cost of this policy does not appear as an explicit subsidy, but as the difference between operating costs and the user charges collected. Electric power is also supplied at a subsidised average rate, whose cost is partly borne by the state’s budget, and partly financed by off-budget borrowing, by the utilities with state guarantee. Education grants are the next most important explicit subsidy – a transfer from the state budget to non-government educational institutions in the name of “grants-in-aid”. The power subsidy is the largest of the lot, and its implicit component adds to the contingent liabilities of the state government. The power subsidy as a ratio of GDP was around 1 per cent in 2005-06(RE) having declined slightly from 1.2 per cent in 2002-03. While absolute levels of subventions have declined in recent years cross subsidies have increased [RBI 2006]. According to the Economic Survey of India 2006-07 while the direct transfers from state governments to State Electricity Boards (SEBs) was Rs 13,870 crore an uncovered subsidy of Rs 21,201 crore remains, indicating the large potential for improving not only the SEBs’ finances but also the fiscal position of states. Figure 4 shows the performance of the SEBs by looking at the change in transmission and distribution (T&D) losses. While most states show a marked improvement there is still a long way to go.

The TWFC considered those states whose outstanding debt was higher than 300 per cent of their revenue or interest higher than 20 per cent of revenue, as being “debt stressed”. Given an average interest rate on state debt of around 8 per cent, an upper limit of 250 per cent for outstanding debt and guarantees in relation to a state’s revenue would be broadly consistent with an interest burden of 20 per cent of revenue. The degree to which different states have approached this target is shown in Table 1. Among the debt stressed states, two categories can be identified, viz (i) the highly debt stressed, where debt is over 275 per cent of revenue in

salary bill, whose nominal growth in recent years is shown in Figure 3.5 The jump in salary bill in Kerala in the latest year, 2005-06, is due to the fact that it implemented a state-specific pay hike in that year. Other than this outlier, the difference in growth rates between states generally reflects the different degrees of containment in the size of the civil service. While some states have maintained the size intact since 2002, by hiring roughly as many as leave the service each year, others (such as Orissa) have achieved significant attrition-based downsizing by hiring much less than annual retirees, and by abolition of vacant base level positions in all but a few departments and functions. Containment of the salary bill has been assisted also by the practice of hiring

Economic & Political Weekly

EPW
september 20, 2008

Figure 3: Growth in Salary Bill (nominal in %) 2005-06 or debt plus guarantees over

16 12 8 4 0

2002-06

2002-07

350 per cent in 2004-05; and (ii) the moderately debt stressed, where the above mentioned ratios are in the 225275 per cent and 250-350 per cent ranges respectively. According to this criterion, the states that fall in the dif

ferent categories are: Highly Debt Stressed: West Bengal,

AP BH HY KNKR MP MH ORRJ TNUP WB

Figure 4: Change in T&D Losses between 2004-05 and 2001-02

Punjab, Rajasthan, Kerala, Gujarat,

(in percentage points; Negative number implied T&D losses have fallen)

and Maharashtra.

Andhra Pradesh –12.9 Karnataka –12.8

Moderately Debt Stressed: Andhra

Orissa –11.7

Himachal Pradesh Haryana Madhya Pradesh West Bengal Uttar Pradesh India Punjab Maharashtra Gujarat Tamil Nadu Kerala Rajasthan Bihar

–15

Pradesh, Bihar, Orissa, and Uttar

–8.0 –7.8

Pradesh.

–4.8 –4.7

Non-Debt Stressed: Haryana, Karna

–2.0 –1.8

taka, Madhya Pradesh and Tamil Nadu.

–1.5

A visible and widely observed pheno

–1.4

2.2 menon in recent times is the accu

3.5

3.7 mulation of positive cash balances

15.0

18.0 with state governments. Outstanding –10 –5 0 5 10 15 20 investments by the states in treasury

SPECIAL ARTICLE

bills crossed Rs 60,000 crore (1.5 per cent of GDP) by end March these two, giving equal weight to each, has been used to measure 2007, which is about 5 per cent of states’ total outstanding debt. progress towards debt sustainability. One must be careful not to interpret this phenomenon as a The combined indicator of the “strength of fiscal correction” structural improvement in state finances. It is not only small in has been defined as the weighted average of the following variacomparison to the debt stock but also largely a temporary pheno-bles during the period 1998-2000 to 2005-06: (i) The revenue menon, caused by (i) the jump in central transfers following the balance index which measures the relative reduction in the award of the TWFC, starting 2005-06, and (ii) rapid growth in revenue deficit (one-third weight); (ii) The debt sustainability both central and state tax revenues, with delayed response of index (one-third weight) which in turn is an equal combination expenditures to the availability of additional resources. The degree Table 2: Indicator of Strength of Fiscal Correction (1998/2000-06)

States Revenue Balance Index Debt Sustainability Index Own Revenue Effort Index

to which the rise in cash balances is temporary can be seen from

Reduction in Own Primary Debt Level in Difference Combinedthe trend in utilisation of ways and means advances and over- Revenue Deficit Stock 2005-06 (1998-2000 to Index Deficit Correction Ratio Relative to 2005-06)

drafts by the state governments: the average daily outstandings

Karnataka Relative to Orissa

were below Rs 300 crore for all states put together during most of

West Bengal 0.4 0.4 -0.2 0.3 0.1 0.25

2006-07, but rose to around Rs 1,700 crore by September 2007.

Kerala 0.4 0.4 0.4 0.6 0.2 0.38

Maharashtra 0.5 0.0 0.5 0.6 0.2 0.38

3 Measuring the Strength of Fiscal Correction

Bihar 1.0 -0.7 0.8 0.3 -0.1 0.39

Fiscal correction may be measured along three dimensions or cri-

Gujarat 1.0 0.5 0.5 0.5 -0.5 0.48 teria. First, there is the principle of the “golden rule”, which has Uttar Pradesh 0.9 -0.1 0.8 0.5 0.6 0.58 wide acceptance in India – the principle that the government’s Punjab 0.6 -0.3 0.3 0.8 1.1 0.60 current account must not be in deficit, or in other words, borrow-Rajasthan 0.9 0.1 0.4 0.6 0.8 0.62

Madhya Pradesh 1.0 -0.3 1.0 0.6 0.5 0.62

ing must only be undertaken for financing capital investment,

Andhra Pradesh 1.0 0.1 0.8 0.6 0.4 0.66

i e, for the creation of productive assets. The golden rule plays a

Orissa 1.1 0.5 0.7 0.6 1.0 0.85

central role in the form of the revenue deficit (i e, deficit on cur-

Haryana 1.2 0.5 1.0 0.7 1.0 0.94

rent account) and the goal of eliminating it by 2008-09, a target

Tamil Nadu 1.3 0.5 1.2 0.7 0.8 0.96

that has been institutionalised through fiscal responsibility leg-

Karnataka 1.8 0.6 2.0 1.0 1.8 1.48 islation and is the single most important annual monitorable (1) Debt Sustainability Index = 1/2 (Own Primary deficit correction) + 1/2 (Debt Stock ratio).

(2) Own Revenue Effort Index =1/2 (Own Revenue relative to Karnataka in 2005/06)+1/2

indicator. Second, there is the requirement of debt sustainability (Difference relative to Orissa).

(3) Combined Index =1/3 (Revenue Deficit Correction)+1/3 (Debt Sustainability Index)+1/3

– ensuring that the burden of servicing debt and guarantees do not

(Own Revenue Effort Index). pre-empt too high a share of the state’s revenues – which requires (4) Own Primary Deficit =States Own Revenues–Non-Interest Expenditure.

reducing and containing the primary (non-interest) fiscal deficit, of the state’s own effort at reducing primary deficit; and closeand controlling guarantees. Third, there is the performance of ness of its current debt stock to the desired 250 per cent limit on the state in enhancing its own revenue, which is being used as a outstanding debt and guarantees as ratio of revenue; (iii) own proxy for the quality of fiscal adjustment. revenue effort index (one-third weight) which is a combination of

The TWFC recommended that the revenue deficit of states be increase in own revenue to GSDP ratio; and the closeness to the eliminated by 2008-09. Taking 1998-2000 as the base, states own revenue to GSDP ratio of the leading state (Karnataka). need to achieve 100 per cent reduction by 2008-09, as they are Figure 6 shows a scatter plot with the strength of fiscal correction committed to eliminate the revenue Figure 5: Progress on Golden Rule (as defined by our index) on the x-axis

Absolute correction (% GSDP) – right
Relative correction (%) – left

deficit by that year and convert it into 200

8 and per capita income on the y-axis. It a surplus. The majority of states have

is interesting to note that the disparity

160 6

already achieved or are close to in the strength of fiscal correction is

120

achieving this target, with the excepnot positively correlated with per

4 tion of Kerala, Maharashtra, Punjab 80

capita income – that is, higher income and West Bengal (Figure 5).

2 states have not achieved a stronger

40

Progress towards debt sustainafiscal correction than the middle and

0 0

bility could be measured by (i) the low-income states. Among the low-

AP BH GJ HY KNKRMP MH ORPJ RJ TNUP WB

state’s own effort to reduce its pri-income states, one has achieved a

Figure 6: Fiscal Correction and Per Capita Income (2005)

mary deficit, and (ii) the distance re

strong fiscal correction while three maining to emerge out of a debt 40,000

MH HY others have achieved moderate correc-

GJ PJ

stressed condition, i e, the degree to tion. Among the high-income states,

30,000 AP

TN

WB KR KN

which debt plus guarantees exceed on the other hand, two out of four are

RJ20,000

250 per cent of the state’s revenue.

in the weak correction category though

MP OR

The former is a measure of how much

10,000 BH UP Gujarat is a borderline case. Poorer the situation has improved since the 0

states have performed better than

0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40 1.60

base period of 1998-2000. The latter Weak Strength of Strongexpected, while some of the most fiscal correction

is a measure of how much gap still re-developed states have performed

Per capita income up to Rs 20,000 is low and high thereafter; Fiscal correction mains to be bridged. A combination of below 0.40 is weak and above 0.80 strong. worse than one would have expected.

60 september 20, 2008

SPECIAL ARTICLE

Ratios concerning the composition of expenditure, such as the proportion of capital spending or of non-salary recurring expenditure, have not been included in measuring the strength of fiscal correction in this paper. This is not because they are unimportant, but because (a) comparison of quantities while ignoring quality of spending could be misleading; and (b) available data on non-salary recurring expenditure across states have significant non-comparability problems.

A comparison of Orissa and Uttar Pradesh can illustrate the problem of using the proportion of capital in total expenditure as an indicator of quality of fiscal correction. Capital expenditure rose steeply in UP during 2004-06, especially on roads, but outcomes did not improve commensurately, as the procurement of contracts has been dominated by the prevalence of “mafias” in the construction industry in the state. In contrast, Orissa has managed to improve outcomes despite a tightly constrained capital budget that remained flat in rupee terms during 2002-05. The constraint on capital spending during the adjustment period was turned from a liability into an asset, to focus attention on speeding up completion of investment projects and on delivery of benefits (see Box on Zero-Based Investment Review).

Box 1: Zero-Based Investment Review in Orissa
Several infrastructure projects taken up by the Orissa government were languishing due to spreading resources too thinly across too many projects. Consequently, the government of Orissa in 2002-03 launched an exercise called Zero-Based Investment Review (ZBI) led by a high-powered committee headed by the chief secretary. The ZBI review required each department to place the projects under four categories: (i) full funding for fast track completion; (ii) funding on slower track for the present, which could graduate to fast-track in the future; (iii) minimal funding until redesign or restructuring; and (iv) scrap or shelve indefinitely. In the first phase, the review was limited to projects/schemes costing Rs 4 crore and above; and in the next phase projects costing Rs 1 crore and above were also taken up for completion. During the last four years of implementation of the scheme, out of 257 identified projects, as many as 90 projects have been completed up to December 2005. Yearwise allocation of budget and project completion details are given in the table below.
Year Budget Estimate No of Projects No of Projects No of Bridges (Rs Crore) Identified Completed Completed
2002-03 89 41 17 N A
2003-04 193 60 24 N A
2004-05 138 41 19 19
2005-06 183 115 30 85
2006-07 66 128 86 128
For timely completion of the identified projects, concerned departments have been allowed to make necessary provision in the budget, including reallocation of funds within the overall budgetary ceiling. The success of this exercise shows that when the total budget allocation is held constant, positive incentives are created for departments to reallocate funds to priority projects rather than hide “white elephants” to protect budgetary resources. Completion of long pending roads and bridges connecting hitherto remote villages became a visible “quick win” that the government publicised for strengthening public support for the reforms.
4 Lessons for States

The experience during 2000-06 has several important lessons for states, especially those that lag behind in terms of aligning with a sustainable and adequate fiscal correction path. The most important among them are the following: Substantial increase in a state’s own revenue is possible through reforms in tax policy and administration, which would expand the tax base (by reducing evasion) as well as enhance tax buoyancy; including effective implementation of the VAT. Fiscal discipline can also enhance output and outcomes of public spending (as seen from Orissa’s success with the “Zero-Based Investment Reviews”) if the state leadership can use overall financial constraints as a factor to strengthen attention on what gets delivered on the ground rather than merely on how much is spent. Fiscal discipline is possible even without political stability, provided the finance department uses the regime of performance linked central transfers effectively (as has happened to some extent in UP).

Overall, an important lesson for the states is that following the TWFC award, it is now certainly possible for all the major states, including the poorest and most indebted ones to meet the recommended targets of maintaining the golden rule plus a sustainable overall deficit of no more than 3 per cent of GSDP, starting 2008-09. Turning this possibility into reality and sustaining such a fiscal stance requires strong political commitment to fiscal discipline. Where there is a will, there are certainly feasible ways to improve state revenue performance and to reign in unproductive expenditures, thereby making way for the most effective development interventions and investments.

5 Lessons for the Centre
  • (i) Instilling fiscal discipline among states is still an unfinished agenda: Recent improvements in the incentive framework for fiscally responsible behaviour by the state governments have brought about desired change in the fiscal stance of several, but clearly not all the states. The fiscally weaker states have tended to take centrally recommended targets more seriously, because the central incentive grants and performance-linked debt relief mean more to them. This raises the question: what is to be done to incentivise the others, including some of the high income and fast growing states, to commit to fiscal discipline?
  • (ii) Strengthening of market-based discipline: The most effective way to enforce fiscal discipline among all states is to expose them to credit rating and risk-based lending terms, by phasing out central guarantee or any kind of central support, so as to let states access the financial market on their own strength. This would require financial institutions, owned by the central government, to also discipline their lending practices – to prevent them, for instance, from lending to bankrupt or unviable institutions and agencies, including unsecured loans to loss-making state-owned power utilities. The TWFC recognised the merits of market-based fiscal discipline, considering it a long-term goal. However, given the significant fiscal correction achieved in recent years, especially by the low income states, along with enhanced central transfers for them, the “long-term” goal could be brought
  • available at

    Delhi Magazine Distributors Pvt Ltd

    110, Bangla Sahib Marg New Delhi 110 001 Ph: 41561062/63

    Economic & Political Weekly

    EPW
    september 20, 2008

    SPECIAL ARTICLE

    forward. Rationalising and disciplining the centrally owned lend-guarantees (perhaps as a ratio of total revenue receipts) could be ing institutions is a good place to begin. a better package than the golden rule plus annual targets for fiscal

    (iii) Monitoring of stock instead of flow: Requiring every state deficit, as is the system being followed at present. government to reduce the annual deficit in every year restricts

    Table A1: States’ Own Revenues-Rankings (1998-2000 to 2005-06)

    flexibility in fiscal management at the state level. As far as Own Revenue/GSDP 1998-2000 Rank-98 2005-06 Rank-05
    the objective of fiscal sustainability is concerned, it is possible to Andhra Pradesh 8.84 7 10.71 6
    achieve the same aim by monitoring end-of-year stock of Bihar 6.45 11 5.90 13
    debt and liabilities. The advantage of monitoring stock instead of Gujarat 10.02 1 8.09 12
    flow is that an over-achievement of target in one year would offer Haryana 8.33 5 12.51 4
    a cushion for the state in the next year, which could be used to Karnataka 9.62 2 17.00 1
    deal with temporary one-time shocks. Thus, if a state had the target of confining end-of-year debt stock within X in the current KeralaMadhya Pradesh Maharashtra 8.91 7.69 8.57 6 9 8 9.55 9.62 9.49 9 8 10
    year and Y the following year, and if actual outcome in the Orissa 6.00 13 10.19 7
    current year ends up at X – d, overachieving the target, then in Punjab 9.43 3 13.88 2
    the following year it would still be required to end up at less Rajasthan 7.50 10 10.77 5
    than equal to Y, which implies that it could borrow a bit more Tamil Nadu 9.31 4 12.52 3
    than originally projected. The golden rule (i e, elimination of Uttar Pradesh 6.11 12 8.47 11
    revenue deficit) plus targets for end-of-year debt and outstanding West Bengal 4.45 14 4.89 14

    Notes 4 The 2006-07 budget of the government of Gujarat References 1 Fiscal Balance=Revenue Receipts–Total Expendi-Rao, M Govinda (2002), ‘State Finances in India:

    announced amnesty schemes for defaulters of

    ture (Revenue + Capital) sales tax and stamp duty payments, and also Issues and Challenges’, August 3, Economic & lowered electricity duty for various consumer

    2 Throughout this paper correction during 2000-Political Weekly. 06 has been calculated by comparing outcomes in categories. Reserve Bank of India (2005): State Finances Study of 2005-06 with the average during 1998-99 and 5 The year 2001-02 has been selected as the Budgets 2005-06, Mumbai.1999-2000, the period when deficits peaked in all base for calculating growth in the salary – (2006): State Finances: Study of Budgets 2006-07, the major states. bill because of the bifurcation of Bihar, Mumbai.

    3 Royalty rates for major minerals are set by the centre, Madhya Pradesh and Uttar Pradesh in the World Bank (2005): State Fiscal reforms in India: while all royalty revenues accrue to the states. year 2000. Progress and Prospects, Macmillan Press.

    Sage

    september 20, 2008

    Dear Reader,

    To continue reading, become a subscriber.

    Explore our attractive subscription offers.

    Click here

    Comments

    (-) Hide

    EPW looks forward to your comments. Please note that comments are moderated as per our comments policy. They may take some time to appear. A comment, if suitable, may be selected for publication in the Letters pages of EPW.

    Back to Top