Even as the fiscal health of States has rebounded from pandemic-induced stress, the likely reversion to the old pension scheme (OPS) by some States is a major risk looming large on the sub-national fiscal horizon, according to the Reserve Bank of India’s report on State finances.

Among the States, Chhattisgarh, Rajasthan, Punjab, and Himachal Pradesh have so far restored the OPS for government employees.

“The annual savings in fiscal resources that this (OPS) move entails is short-lived. By postponing the current expenses to the future, States risk the accumulation of unfunded pension liabilities in the coming years,” per the report, whose theme is “Capital Formation in India: The Role of States.”

Increased allocations

The report underscored that going forward, increased allocations of capital expenditure for sectors like health, education, infrastructure, and green energy transition can help expand productive capacities and create a broad-based developmental agenda for States.

“Outlays on social services and physical infrastructure can enhance productivity; hence, States must mainstream capital planning rather than treat them as residuals and first stops for cutbacks in order to meet budgetary targets,” it added.

In this context, the report suggested that it is worthwhile to consider creating a capex buffer fund during good times when revenue flows are strong so as to smoothen and maintain expenditure quality and flows through the economic cycle.

Climate change policies

The report noted that there is a growing recognition of the need for responsible climate change policies at the State level in areas such as clean energy, energy efficiency, clean transport, and sustainable land use, among others.

Capacity building on access to finance and climate governance would help States meet their potential and realise the committed national target of net zero emissions by 2070.

“In this regard, climate-incentivised borrowing ceilings may encourage States to issue green bonds in order to finance green projects. Also, within the Scheme for Special Assistance to States for Capital Investment, a separate head for climate-related investment projects can be created,” the report recommended.

Focus on congenial ecosystem

To crowd in private investment, the report said State governments may continue to focus on creating a congenial ecosystem for the private sector to thrive. States also need to encourage and facilitate higher inter-State trade and businesses to realise the full benefit of spillover effects from State capex across the country.

The fiscal health of States has rebounded from pandemic-induced stress, aided by buoyant revenue collections and prudent expenditure management, the report said, adding that the undershooting of budgetary targets for key deficit indicators has enabled States to reduce their outstanding liabilities. These developments have extended into 2022–23 so far.