New learnings

Updated on: Dec 05, 2021
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RBI’s State finances report rightly focuses on municipal bodies and quality spending

The pandemic has upended fiscal balance all around, but the good news is that some structural changes might ensue from the experience. The Reserve Bank’s latest report on State finances for 2020-21 reveals some key learnings. The first is the need to bolster the finances and political robustness of the third tier of government, namely, urban local bodies and panchayati raj institutions, which have done much of the heavy-lifting in managing the pandemic. The second is the implicit recognition that the fiscal deficit to GDP ratio need not be a number cast in stone, but one that may be revised within a band according to the exigencies of the day — a point of view that the Fifteenth Finance Commission seems to endorse as well. A unifying aspect in these two strands of thought is a revenue-led fiscal management approach, with a realisation that capex and health spending should not be allowed to suffer.

The pandemic has put the spotlight on the performance of local governments like perhaps never before — be it managing hospitals, vaccination centres, quarantining and testing facilities or sanitising environs. The RBI’s qualitative survey of over 140 municipal bodies and a more detailed examination of 20 large ones, is revealing. The report observes: Their “inability to meet the budgetary target of expenditure on public services in 2020-21 even at the time of pandemic reflects their fiscal constraints arising out of revenue shortfalls and limited opportunities for market borrowings, as statutorily they cannot run a deficit.” The RBI study reveals that 22 per cent of the municipal bodies surveyed by them reported a revenue loss of more than 50 per cent in the second wave, while 11 per cent reported an expenditure spurt of over 50 per cent. This will dent their capacities to maintain infrastructure. Their ability to raise funds through property taxes and user charges needs to be improved. The RBI report rightly urges “greater fiscal transparency, revitalising the municipal bond market and boosting infrastructure finance and green finance”.

Meanwhile, the States’ fiscal deficit to GDP ratio of 4.7 per cent in 2020-21 is expected to come down to 3.7 per cent (still above the magic figure of 3 per cent) in 2021-22. This has been driven by a growth in revenue receipts of States this fiscal, which were up by 8 per cent over 2019-20 in the first half. The RBI observes that the revenue lost from foregoing taxes on fuel will be made up by a process of economic recovery, “especially if the States abstain from spending cuts to compensate their revenue loss”. A focus on keeping up quality spending — not cutting capex to meet fiscal targets — is telling at a time when the States’ debt to GDP ratio is up at 31 per cent, from 25 per cent five years ago. This takes the public debt to GDP ratio to 90 per cent, a level beyond which, according to a some economists, growth falters. An incentive-based approach to managing the fisc, such as allowing fiscal space for Discom reforms, is the way forward.

Published on December 05, 2021

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