The Hindu Business Line : Inflation pressure hits States' fiscal reforms

RISING revenue expenditure as a result of accelerating inflation and rising interest rates has jeopardised States' fiscal reforms. Sources said most States were now likely to face large escalations in administrative expenditure, mainly due to increasing salaries and pensions.

States had expected that this year inflation would be contained at 5 per cent. However, soaring oil prices have completely belied these expectations. Inflation was now on the verge of breaching the eight-per cent mark.

Dearness allowance compensation is based on the consumer price index-derived inflation. CPI for both industrial workers and urban non-manual workers has traditionally remained at least 1.5 per cent to 2 per cent above the WPI-measured inflation. This implied that salaries and pensions would have to factor the higher rates of inflation for compensation.

Accordingly sources said whatever benefits some of the States had derived by way of manpower reduction during the last few years would considerably be negated.

For 2003-04, the wage bill of States amounted to Rs 31,000 crore and pensions accounted for another Rs 44,000 crore.

Sources said growth in both these expenditures was expected to have been contained at about six per cent, if inflation had remained at five per cent.

However this year, the actual growth was likely to overshoot these estimates and rise at close to about 10 per cent, the sources said, based on current inflationary trends.

Moreover, the sources said the soaring oil prices would also impact other arms of the state governments, especially the transportation sector, which is heavily subsidised.

Transport subsidies comprise at least one per cent of the state domestic product (SDP). But a few states are prepared to pass on the escalated expenditures to users. Instead most of them are preparing to absorb them.

As a result, transport subsidies were likely to rise, further bleeding State finances, the sources said.

The sources also said trends of auctions of state development loans also indicated rising interest costs. Ten-year State development loans are currently being quoted at a yield of 7 per cent. Last year, States had raised ten-year loans at rates as low as 5.6 per cent.

Besides, this year a few debt swaps have taken place for replacement of central non-Plan and Plan loans with market borrowings, unlike last year.

As a result, the sources said States interest costs would remain high.

Interest costs for States in 2003-04 were Rs 83,000 crore despite the debt swaps and reduced costs of incremental borrowings. These costs however, were exclusive of budget borrowing by the State Government.

As a result, the sources said none of the States wasin a position to reduce sales tax rates on petroleum products.

Reduction of these rates would imply that the fiscal pressures on the States would escalate.

Most States at present have a fiscal deficit of anywhere between 3 and 6 per cent of their respective SDPs.

Any reduction in the tax rates, the sources said, would lead to a further escalation, unless alternative revenues could be raised.