The Reserve Bank of India (RBI) today released “State Finances: A Study of Budgets of 2010-11”, a publication that provides data, analysis and assessment of finances of State governments.

The State governments presented their budgets for 2010-11 against the backdrop of an economic recovery and improving growth prospects for the Indian economy. Reflecting these positive developments, States had budgetted higher growth in own tax revenues in 2010-11 than in 2009-10 (RE). In addition, States also expected a larger devolution from the Centre in the form of share in Central taxes during 2010-11. The States had undertaken a massive expansion in aggregate expenditures in the previous two years in the wake of the overall macroeconomic slowdown and implementation of the Sixth Central/State(s) Pay Commission recommendations. They, therefore, budgetted a modest rise in their aggregate expenditures during 2010-11. All these factors indicated a move towards the resumption of the fiscal consolidation process at the level of States in 2010-11 after a slippage in the previous two years.

Role of Finance Commissions

The theme Chapter on “Finance Commissions in India: An Assessment” in the Study examines the role of Finance Commissions (FCs). The Chapter notes that apart from the constitutional tasks of deciding the proportion of tax revenue to be shared with the States and the principles governing the grants-in-aid of the revenues of the States, the scope of the Finance Commissions has broadened over time as they were assigned several other issues on government finances, particularly those relating to augmentation of State Consolidation Funds to supplementing the resources of local bodies and debt-related issues. An assessment of the equalisation component of transfers as recommended by four successive FCs (from the Tenth to the Thirteenth) shows that it was the highest in the case of Eleventh FC as the gap between recommended and benchmark transfers was minimum.

Issues in State finances

The Study also highlights factors which are likely to have significant implications for fiscal consolidation at the States’ level while recording immediate and medium-term issues on State finances. While the overall macroeconomic environment and pace of economic recovery would remain important for State finances, other factors including implementation of goods and services tax (GST), States’ own efforts towards mobilising non-tax revenues and prioritisation/rationalisation of expenditure would have implications on fiscal consolidation at the State level. To make credible progress towards fiscal consolidation, States need to amend their FRBM Acts and workout a fiscal reform path. States also need to review their tariff policies especially those relating to the power and irrigation sectors. Better allocation of expenditure along with improved transparency and accountability through stricter audit procedures would also be desirable to ensure improvement in resource use and fiscal management. States need to put in place an effective forecasting and monitoring mechanism for their cash inflows and outflows so that a need-based approach to market borrowings is adopted. The strengthening of State Finance Commissions is essential to ensure allocation of adequate resources to local bodies, keeping in view their developmental role for the purpose of inclusive growth.

Major findings of the Study

States’ commitment towards fiscal consolidation evident in 2010-11

·         The budgetary position of States in 2010-11 indicated a turnaround from the expansionary fiscal stance in 2008-09 and 2009-10 to a fiscal consolidation path in 2010-11. An improvement in State finances is evident with a majority of the States budgeting either a revenue surplus or a lower revenue deficit in 2010-11 (BE) as compared with 2009-10 (RE). At a consolidated level, the revenue deficit is placed lower at 0.3 per cent of GDP during 2010-11 (BE) as against 0.7 per cent in 2009-10 (RE) reflecting compression in revenue expenditure.

·         With an improvement in the consolidated revenue account of States, the gross fiscal deficit as a ratio to GDP (GFD-GDP) is estimated to decline to 2.5 per cent in 2010-11 (BE) from 3.3 per cent in 2009-10 (RE).

Improvement in key fiscal indicators to be broad-based across States

·         An improvement in State finances in 2010-11, based on the budgetted data, is broad-based and is reflected in lower GFD-GSDP ratios in the case of 22 States. Of the 17 non-special category States, 11 States have budgetted lower GFD-GSDP ratios in 2010-11. All special category States have budgetted lower GFD-GSDP ratio during the same period.

·         A majority of the States expect higher tax buoyancy (including own tax and tax devolution from the Centre), while non-tax revenues (own non-tax revenues and grants from the Centre) are budgetted to decline in 18 States.

·         The revenue expenditure as ratio to GSDP is budgetted to decline in 19 States, which is likely to be a major source for correction in their revenue accounts.

Decline in key expenditure ratios raises concern regarding the quality of fiscal adjustment

·         The emerging pattern of expenditure shows that as a ratio to GSDP, development expenditure, capital outlay and social sector expenditure are budgetted to be lower in many States, raising concerns about the quality of fiscal adjustment being undertaken at the State level.

Decline in States’ overall debt-GDP ratio to continue in 2010-11

·         Despite the extra expenditure obligations emanating from the implementation of revised pay structures and fiscal stimulus measures, the impact in terms of debt-GSDP ratios remained muted in most States during 2008-09 and 2009-10 (RE). Importantly, aggregate debt-GDP ratio at 25.0 per cent in 2009-10 (RE) was well below the level of 30.8 per cent recommended by the Twelfth Finance Commission (FC). In 2010-11 (BE), the aggregate outstanding debt-GDP ratio of States is likely to decline further to 23.1 per cent, reflecting higher growth in GSDP than that in outstanding debt.

·         The declining trend in debt-GDP ratio would have favourable implications for interest payments (IP) relative to revenue receipts (RR). State-wise data show that 11 States were able to align their IP-RR ratios with the Twelfth FC’s target of 15 per cent by 2009-10. The overall IP-RR ratio is budgetted to decline to 14.1 per cent in 2010-11 from 14.4 per cent in 2009-10 (RE), though it remains very high in some States.

 

The publication has been prepared in the Fiscal Analysis Division (FAD) of the Department of Economic and Policy Research. Starting 2001-02, this publication is available on RBI website (www.rbi.org.in). Comments on this publication may be sent to Director, Fiscal Analysis Division, Department of Economic and Policy Research, Reserve Bank of India, Shahid Bhagat Singh Road, Mumbai-400001. Comments can also be sent via e-mail.

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