G. Srinivasan

New Delhi, Jan. 26

BEING the banker and debt manager to the State Governments, the Reserve Bank of India has deemed it fit to draw attention to the persistence of "weaknesses in State Government finances," stating that "fiscal empowerment holds the key to enduring fiscal correction and to provide adequate resources to finance developmental spending."

In its latest monthly bulletin highlighting `Finances of State Governments 2004-05' with an updated version of the same subject from its 2003-04 annual report released a couple of weeks ago, but incorporating 29 State budgets as well as additional information from the States and the Centre, the apex bank minces no words about the dismal state of State finances. The weaknesses of the State finances manifest mainly in the sluggish non-tax revenue, downwardly rigid non-developmental committed expenditures and inadequate allocations for education, health and infrastructure. Left uncorrected, this risks fostering a development deficit of a serious dimension.

Commenting on the trends in State finances, the RBI study said the reduction in fiscal imbalances during the period 2000-01 to 2002-03 turned out to be "transitory," with the revised estimates for 2003-04 revealing a marked deterioration in the key deficit indicators from their respective level in the budget estimates. The gross fiscal deficit of the State Governments was placed at 5.1 per cent of the gross domestic product (GDP) in the revised estimates for 2003-04 as compared with 4.2 per cent in the Budget estimates.

The fiscal imbalance flowed largely from higher revenue and capital expenditures in respect of the power sector that was compounded by a decline in revenue receipts. The widening of the revenue deficit was primarily on account of a shortfall in States' own taxes, mainly in respect of State Excise duties, Centrally sponsored schemes, a substantial spurt in revenue expenditure on power projects and a decline in grants from the Centre. It is also instructive that the States' own non-tax revenues have been an area of perennial concern. A major reason for the sluggish growth in non-tax revenues is the levy of inadequate user charges and this is reflected in jejune recovery of public services. Low or negative returns from investment have further hit the growth of States' own non-tax revenue.

Again, in 2003-04, non-developmental expenditure, as a ratio to GDP, maintained its relentless up-trend to 6.4 per cent of GDP and within this segment, interest payments absorbed over 25 per cent of revenue receipts at the consolidated level. The latter was substantially higher than that of 18 per cent suggested by the Eleventh Finance Commission from the standpoint of debt sustainability over the medium-term. With the penchant of State Governments to ride on populist policies like free electricity and water pronounced, the upshot is the upsetting of fiscal calculations.

Despite this back-sliding in 2003-04 in the fiscal consolidation course, the Budget estimates for 2004-05 show a concerted bid by States to carry forward the fiscal reforms process through a renewed twin-track policy on fiscal empowerment and expenditure containment. But the expected improvement in the States' fiscal position during 2004-05 would also be contingent upon the acceleration in their share in Central tax revenue and the revenue mobilisation efforts of the State Governments.

As the Central tax revenue target is set to be running a sizeable shortfall this fiscal, to this extent, the likely improvement in the States' fiscal position would suffer. This must also be seen in the context of the State Budgets, the RBI said, adding that gross devolution and transfer of resources from the Centre would decline to 5.5 per cent of GDP this fiscal from 5.7 per cent in the previous year and 6.8 per cent, on an average, during the first half of the 1990s.

It is also disquieting to note that social sector spending of the States is estimated to decline to 5.4 per cent of GDP this fiscal from 5.9 per cent last year and within this, provisions for education and health are estimated to decline from 2.52 and 0.72 per cent in 2003-04 to 2.37 per cent and 0.67 per cent respectively in 2004-05.

A worrisome development is that besides boosting the level of debt, the outstanding guarantees of State Governments have increased from 4.4 per cent of GDP as of March-end 1996 to 8.1 per cent of GDP as of March-end 2001 and were placed at 7.5 per cent (Rs 1,84,294 crore) of GDP as of March-end 2003.

In sum, the RBI study plainly puts that the correction envisaged in the Budget estimates for 2004-05 seeks to reduce the fiscal imbalances (in relation to GDP) to the levels prevailing around the mid-1990s, implying the huge tasks on hand to States if they are to stay afloat and bring about economic development without slipping into any fiscal quagmire.

(This article was published in the Business Line print edition dated January 27, 2005)
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