The Hindu Business Line : RBI study of State finances — Persist with fiscal correction and consolidation

The RBI's suggestions would go a long way in committing resources for productive investments in real sectors of the economy to ensure higher employment and asset creation on a lasting basis.

The study of State finances with a scrutiny of their 2006-07 Budgets by the country's central bank, the Reserve Bank of India (RBI), is a diligent exercise into the nitty-gritty of their fiscal position, warts and all. In making a trend analysis of the deficit indicators, through meticulous study of the finances of the State governments, to establish improvements in recent years, this voluminous tome of the apex bank stands out for its analytical rigour, presentation of responses to redress problems and putting the issue in perspective.

At the outset, it contends that the efforts of the State governments to reduce fiscal imbalances were bolstered by greater devolution and transfer through shareable central taxes and grants by the Twelfth Finance Commission (TFC). This is complemented by all States, except Tamil Nadu and Uttar Pradesh, which have implemented Value Added Tax (VAT) in lieu of sales tax. This is likely to provide buoyancy to tax mobilisation of the States.

Improved fiscal performance

The RBI analysis reveals a definite improvement in key deficit indicators. In the 2005-06 revised estimates (RE), gross fiscal deficit and revenue deficit, as ratios to gross domestic product (GDP), declined to 3.2 per cent and 0.5 per cent, respectively. Such a correction has been primarily due to revenue enhancements with revenue receipts, as ratio to GDP, rising 1 per cent over the previous year and States' own tax receipts rising 0.3 per cent.

In sharp contrast to this, about half of the State governments revealed deterioration in non-tax Gross State Domestic Product (GSDP) ratio during 2005-06 over 2002-05, with the median value of non-tax GSDP ratio lingering constant at 2 per cent. While Goa, Punjab and Chhattisgarh continued to hold the highest ranks in terms of own non-tax GSDP ratio, Bihar, West Bengal, Kerala and Uttar Pradesh occupied the lowest slots.

The low level of non-tax revenue has been partly due to low cost recovery (i.e., ratio of non-tax receipts to non-Plan revenue expenditure) from sectors such as education, medical and public health and family welfare, irrigation, power and roads — crucial areas, which kept these States backward for too long.

Particularly noteworthy is that according to the RE of 2005-06 the fiscal performance of State governments improved compared to the Budget estimates, especially in the revenue account, reversing the usual trend of decline in fiscal performance in the RE. The higher grants, coupled with the incentives provided by the TFC towards restructuring of finances have aided States in their effort of fiscal correction and consolidation. Besides, Budgetary rules framed under fiscal responsibility legislation have played a composite role in dissuading States from slipping on their Budgeted fiscal track.

The asymmetry

However, in the 2006-07 State Budgets, there are wide variations across the States despite the marked improvement in consolidated fiscal position. A few States (four) budgeted for an increase in revenue deficit and several budgeted for higher gross fiscal deficit (14) with "only a few States" likely to account for "the major part of the overall correction."

It is also interesting to note that the non-special category States (excluding the so-called backward and regionally disadvantaged ones by distance) would account for more than 87 per cent correction in the revenue account, implying the asymmetry in approach to fiscal consolidation and the need to adapt it across the board. This is all the more important because the State governments have committed in their Budgets to carry forward the process of fiscal consolidation in their Budgets for 2006-07.

Accordingly, gross fiscal deficit and revenue deficit, as ratios to GDP, have been budgeted lower at 2.8 per cent and 0.1 per cent respectively than the 3.2 per cent (RE) and 0.5 per cent (RE) in 2005-06.

Hence the study rightly reminds States that the TFC prescribed for progressive correction in terms of 15 fiscal indicators, which included targets for different items of receipt, expenditure, and debt in addition to targets for deficit indicators.

"Following a holistic approach, the path for fiscal correction and consolidation of the State governments in their scheme of restructuring should emphasise revenue augmentation, compression and rationalisation of expenditure and containment of debt within sustainable limits," the Bank study warns.

Over and above hoisting the warning signal on fiscal imprudence, the central bank urged the State governments to set store by fiscal empowerment to augment revenues i.e., by expanding the scope and size of revenue flows into Budget. This would give them the flexibility to shift the pattern of expenditure. Thus, besides tax reforms, the levying of appropriate user charges, rationalisation of subsidies, including power sector subsidies, and restructuring of State level public sector undertakings assume importance.

Power sector cost recovery

The RBI places primacy on improvement in cost recovery in respect of the power sector, particularly in the wake of extending free power to certain sections by the State governments and the persistent problem of power subsidies.

Quoting official figures showing that the rate of return of State Electricity Boards (SEBs) improved to - 26 per cent in 2005-06 (RE) from - 32 per cent in 2004-05, the RBI said the resources foregone through such insipid rate of return are quite substantial. The gross power subsidy rose about five-fold, from Rs 7,499 crore in 1991-92 to Rs 35,632 crore in 2005-06 (RE). Power subsidy as ratio to GDP remained stagnant at the level of 1.2 per cent during 2002-03 to 2004-05 and declined to one per cent in 2005-06(RE). It asks the States to address the issue of power subsides since power sector reform forms an integral part of the reform process.

It also asks States to provide for a minimum adequate level of social sector expenditure that would lead to subsequent improvement in the human development indicators.

The States need to reprioritise their expenditure to ensure adequate investment in the social sector, besides ensuring, on quality of service delivery in respect of social sectors.

Adverting to the liquidity management, the RBI said the upsurge in surplus cash balances of the State governments has arisen mainly from the large automatic inflow of relatively high cost National Small Savings Fund (NSSF) resources, larger central tax devolution and grants following the TFC award. It said this surge has posed challenges to the cash and financial management and stated that a RBI working group set up to evolve the framework for investment of State government balances is seized of the matter.

The RBI's sound suggestions for persisting with fiscal correction and consolidation course by the State governments would go a long way in husbanding resources for productive investments in real sectors of the economy to ensure higher employment and asset creation on a lasting basis.

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