The Hindu Business Line : India's worsening fiscal imbalance

While the latest RBI Annual Report highlights the real GDP growth of 8.2 per cent during the year, it does not hide its concern over the deterioration of government finances, including those of the States. There is an urgent need to step up public investment in agriculture, infrastructure and social sectors to sustain the growth momentum, but where will the money come from, asks S. D. Naik.

FOURTEEN years after the launch of the process of economic liberalisation that accorded high priority to fiscal consolidation through a gradual reduction in the fiscal and revenue deficits, the problem continues to remain intractable.

Not surprisingly, while the Reserve Bank of India's Annual Report for 2003-04 highlights in glowing terms the country's real GDP growth of 8.2 per cent during the year, it could not hide its growing concern over the steady deterioration of government finances and its long-term consequences for the growth prospects of the economy.

True, the Report refers to some improvement in the Centre's finances in 2003-04 with all the key deficit indicators — gross fiscal, revenue and primary — of the Centre in the revised estimates as well as in the provisional accounts for 2003-04 turning out to be lower than their budget levels. But this is thanks largely to the GDP growth exceeding 8 per cent during the year, a rise in the tax-GDP ratio after seven years on the back of the impressive rise in corporate profitability and the PSU disinvestments target exceeding the budget target after a gap of four years. However, the Report goes on to add that there was an erosion in the health of State finances, with all key deficit indicators rising in the revised estimates for 2003-04 on account of the large increase in expenditure. Moreover, a closer look at the fineprint of the Report reveals that the overall position of the Centre's finances is also far from satisfactory, though the position relating to the State Government finances is much worse.

The outstanding domestic liabilities of the Centre declined only marginally to 60.5 per cent of GDP at end-March 2004 from 60.7 per cent at the end of the preceding fiscal. However, the Centre's internal debt has increased significantly in recent years rising from Rs 7,72,691 crore in 1999-2000 to Rs 10,80,301 crore in 2003-04.

According to an exercise carried out by the Department of Expenditure, it is expected to increase further to a record level of Rs 13,46,712 crore in 2004-05, which would amount to 43.37 per cent of the GDP.

At present, the Centre's revenue expenditure accounts for nearly 85 per cent of its aggregate expenditure and only a little over 15 per cent is available for investment purposes. Of the total revenue expenditure, nearly one-third is accounted for by interest payments, other major items being Defence and subsidies.

While there is an urgent need to step up public investment in agriculture, infrastructure and social sectors to sustain the growth momentum of the economy, one is at a loss to understand from where the money will come.

The ever-rising stock of public debt has fuelled a sharp rise in the Centre's debt service burden, both in terms of repayments and interest payments. For instance, despite the elongation of the average maturity period of dated securities in recent years, the proportion of repayments to gross market borrowings has gone up from the average of 31.5 per cent during 1998-99 to 2002-03 to 39.8 per cent in 2003-04. This is expected to go up further to a new high of 40.1 per cent in 2004-05.

Although the proportion of interest payments to revenue receipts declined from 53.4 per cent in 2001-02, following the big decline in interest rates, it still remained unacceptably high at 47.4 per cent in 2003-04.

The story of State government finances emerging from the RBI data is much more depressing. All major deficit indicators recorded substantial slippages from the budget estimates for 2003-04 and were placed higher than their respective levels in 2002-03.

While the combined revenue deficit of all the States zoomed to around Rs 50,000 crore in 2003-04, their fiscal deficit has shot up to Rs 1,16,000 crore. The 1990-91 figures were Rs 5,309 crore and Rs 18,787 crore respectively.

The large and increasing gross fiscal deficit of the States has led to a steady accumulation of debt over the years. The outstanding liabilities of States have increased relentlessly over the past decade, from Rs 1,60,077 crore in 1993-94 to about Rs 8,00,000 crore in 2003-04. The debt-GDP ratio of States went up from 18.6 per cent to 29.1 per cent over the same period.

As the RBI Annual Report points out, the stress on State finances has emanated from a sluggish growth in States' own tax revenues, deterioration in non-tax revenues, and a persistent increase in revenue expenditure, particularly in respect of the non-developmental component which includes interest payments, pensions and administrative services.

Interest payments alone absorbed more than 25 per cent of revenue receipts of States in 2003-04, substantially higher than that of 18 per cent limit recommended by the Eleventh Finance Commission to ensure debt sustainability over the medium-term. It is not surprising, therefore, that the Finance Ministry's Department of Expenditure, in its recent submission to the Parliamentary Standing Committee on Finance, has expressed concern over the continuous rise in revenue imbalances of State governments. It has pointed out that two items of revenue expenditure — interest and pensions — that do not contribute anything to delivery of public services have been rising sharply and now touched 35 per cent of total revenue receipts of States.

The Department of Expenditure has also expressed concern over a rising trend wherein some States have been resorting to off-Budget borrowings through special purpose vehicles for commercially unviable projects.

Moreover, "States have been quite liberal in issuing guarantees for debt taken by SPVs, public sector undertakings and co-operative organisations leading to large guarantees build up", says the department. The RBI has also expressed its displeasure over this practice, calling it a non-transparent method of borrowing that raises questions of budgetary integrity. Since a significantly large proportion of States' borrowed funds are being utilised for current expenditure rather than capital expenditure, it has an adverse impact on their economic growth and the potential to generate additional resources needed to repay loans and the interest thereon. Consequently, the combined share of revenue deficit of States in their total fiscal deficit has gone up from less than 30 per cent in the first half of 1990s to over 60 per cent by the end of the decade.

With more than 75 per cent of the total revenue receipts of States going towards salary, pensions and interest liabilities, there is hardly anything left for development expenditure. In the case of several major States, this share is more than 85 per cent and in a few cases it has even crossed 100 per cent.

The RBI data released in the latest Annual Report shows that the combined gross fiscal deficit of Centre and States amounted to 9.4 per cent of GDP in 2003-04 (RE), the same as that prevailing in the crisis year of 1990-91.

The combined revenue deficit was 6.2 per cent of GDP in 2003-04, which was even higher than 4.2 per cent in 1990-91. Thus, it is evident that the programme of fiscal reforms has suffered a severe setback. If one adopts the IMF methodology to calculate fiscal deficit, which includes the losses of public sector undertakings, the combined gross fiscal deficit of the Centre and States for India works out to over 11 per cent.

According to a recent IMF study, India's fiscal deficit and government debt are already significantly larger than in most countries with a similar credit rating. For instance, the average debt ratio for countries with a Moody' rating of Ba1 to Ba3 was 61 per cent of GDP in 2003 compared to 85 per cent of GDP for India (Centre plus States). The average fiscal deficit for similarly rated countries is under 4 per cent of GDP, but is 11.5 per cent for India.

More important, the study points out that the public debt-to-revenue ratio (a better measure of debt sustainability) is much larger for India (430 per cent) than for similarly rated countries (289 per cent on average). It is even larger than relatively low rated countries (372 per cent on average). India's high ratio is in part a reflection of a low ratio of Government revenue to GDP, which is just under 20 per cent of GDP.

It is, therefore, evident that unless the Centre and the States succeed in bringing about a phased reduction in the revenue and fiscal deficits as proposed in the Fiscal Responsibility and Budget Management (FRBM) Act 2003, it will not be possible to sustain the growth momentum of the economy. Already, the Planning Commission has indicated that the target of 8 per cent annual GDP growth set for the Tenth Plan period (2002-07) is clearly beyond reach. The economy grew at 4.0 per cent in 2002-03 and 8.2 per cent in 2003-04. It is projected to grow at 6-6.5 per cent in 2004-05.

Hence, even to grow at around 7 per cent per annum during the Plan period, a substantial step up in public investment would be needed to provide a trigger for increased private investment. This would call for comprehensive tax reforms, a drastic reduction in direct and indirect subsidies and a hike in user charges on the services provided by the Government so as to recover the cost of providing them.

Also, there is a need to muster political will to accelerate the pace of reforming the public sector, including the sell-off or closure of loss-making PSUs. In particular, the problem of loss-making PSUs at the State level has assumed alarming proportions. Their mounting losses have been a big drain on the government exchequer. State electricity boards are the major contributors to PSU losses. They have been losing over Rs 22,000 crore per annum in recent years.

In some States, the workers employed in sick PSUs have not received their wages for periods ranging from one to four years and there have been instances of workers and their families committing suicide. While the unprecedented crisis has compelled a few States to seriously consider privatisation or closure of sick PSUs, more needs to be done to tackle the problem.