A Macro View of the Fiscal Health of States

Why in News?

• In India, the States mobilise altogether more than a third of total revenue, spend 60% of combined government expenditure, and have a share in government borrowing that is around 40%.
• Given the size of the fiscal operation of States, an up-to-date understanding of their finances is critical in order to draw evidence-based inferences on the fiscal situation of the country.

 

Fiscal Health, Fiscal Deficit and Revenue Deficit

• Fiscal Health
  • The state and stability of a country or an organisation’s finances and financial affairs are called their financial health.
  • Typical signs of strong financial health include a steady flow of income, rare changes in expenses, strong returns on investments, and a cash balance that is growing.
• Fiscal Deficit
  • The condition when the expenditure of the government exceeds its revenue in a year.
  • Fiscal deficit is calculated both in absolute terms and as a percentage of the country's gross domestic product (GDP).
• Revenue Deficit
  • It occurs when the government's total revenue expenditure exceeds its total revenue receipts.
  • It reflects the inefficiency of the government to reach its regular or recurring expenditure.

 

Fiscal Imbalance at the Central and State Level

• In the first quarter of the fiscal year 2023-24, the increase in general government deficit and debt that occurred during the COVID-19 pandemic has begun to recede.
• There have been significant post-pandemic fiscal corrections at the Union and State levels.
• At the Union level, the fiscal deficit declined from 9.1% of GDP in 2020-21 to 5.9% in 2023-24.
• All State fiscal deficit was 4.1% of GDP in 2020-21. It declined to 3.24% of GDP in 2022-23. For the major States, for the year 2023-24, it is expected to be 2.9% of GDP.

 

Fiscal Consolidation

• 17 major States are responsible for more than 90% of the combined spending of all States which means fiscal issues emerging out of their Budgets are representative of the State finances in India.
• These States together have managed to contain their fiscal deficits. This fiscal consolidation is significant because of following reasons:
  • States in aggregate managed to be fiscally prudent despite a significant contraction in revenues even during the peak of COVID-19.
  • Emergency provision for health spending and livelihood during the COVID-19 pandemic was not easy and required Union-State fiscal coordination.
  • States were able to reprioritise expenditure and quickly contain the fiscal deficit.
  • The reduction in fiscal deficit is a combination of expenditure-side adjustments, improved Goods and Services Tax (GST) collection and higher tax devolution due to buoyant central revenues.
  • Non-GST revenues are also showing signs of recovery after the pandemic in most States.

 

Fiscal Challenges: Containing the Revenue Deficit of States

• The reduction in fiscal deficit has not been accompanied by a corresponding reduction in revenue deficit.
• As in 2023-24, out of 17 major States, 13 States have deficit in the revenue account.
• Out of 13 States, fiscal deficits in seven States are primarily driven by revenue deficits.
• These states are Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal. They also have large debt to GSDP ratios.
• For these seven States, their specific shares of revenue deficit in fiscal deficit for 2023-24 are: Andhra Pradesh (40.9%), Haryana (50.9%), Kerala (60.4%), Punjab (70.7%), Rajasthan (39.7%), Tamil Nadu (40.8%), and West Bengal (47%).
• The all-State share of revenue deficit in fiscal deficit for the same year is expected to be 27%.
• An assessment of successive Finance Commissions since the Twelfth Finance Commission identified three States, i.e., Kerala, Punjab and West Bengal, as fiscally stressed States.
• The number of States that are now fiscally stressed has increased to seven (measured in terms of the level of revenue deficit).

 

What does it Mean for General Government Macroeconomic Stability

• The combined fiscal deficit of these States is 3.71% of GSDP when the all-State average for the same is 2.9%.
• Their combined revenue deficit is 2.15 % of GSDP, when the all-State revenue deficit is 0.78%.
• Their combined debt ratio is higher than the Finance Commission recommended debt ratio for all States for the year 2023-24.
• These States together contribute around 40% to India’s GDP. In this context, to ensure higher State-specific growth, the fiscal stability of State finances is critical.
• Some of these States have also been big drivers of public capital expenditures and favoured investment destinations of private investors.

 

Framework of Revenue Deficit Consolidation

• Data from the last 20 years suggests that revenue deficit had almost disappeared from State Budgets before COVID-19.
• States, in aggregate, were generating revenue surpluses almost all the years during this period.
• However, the re-emergence of revenue deficit in recent years should take the focus back on the management of revenue deficit by creating an incentive compatible framework.

 

Measures to Manage Revenue Deficit Effectively

• Interest Free Loans
  • Interest-free loans to the States by the Union Government may be linked to a reduction in revenue deficit.
  • This will help eliminate the possibility of a substitution of States’ own capital spending and also prevent the diversion of borrowed resources to finance revenue expenditure.
• Defined Time Path: For revenue deficit reduction with a credible fiscal adjustment plan would help restore fiscal balance and improve quality of expenditure.
• Incentive Grants
  • A forward-looking performance incentive grants could also be considered for a reduction of revenue deficit.
  • In this context, different approaches provided by earlier Finance Commissions can be considered to decide the framework of the incentive structure.

Way Forward

• It is true that the mere presence of a revenue deficit cannot be considered as a sign of fiscal profligacy.
• It is also true that pressure on revenue expenditure was high during the COVID-19 pandemic.
• Therefore, a more detailed and careful analysis of the rise in revenue deficit of States is also necessary. 

 

Conclusion

• To manage state finances in an effective manner, a comprehensive revenue deficit reduction framework is essential to improve the fiscal health of States.
• Also, to get the focus back on the management of revenue deficit a macro view is essential.

 

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Q1) What is the difference between Capital Expenditure and Revenue Expenditure?

Capital expenditures are typically one-time large purchases of fixed assets that will be used for revenue generation over a longer period. Revenue expenditures are typically referred to as ongoing operating expenses, which are short-term expenses that are used in running business operations.

 

Q2) How does fiscal imbalance affect the country's economy?

Fiscal imbalance occurs when there is a mismatch between a government's future debt obligations and future income streams. Vertical and horizontal fiscal imbalance are the two types of imbalance that can impact a government's expenditures and revenues. A vertical fiscal imbalance occurs when revenues do not match expenditures for different government levels. A horizontal fiscal imbalance occurs when revenues do not match expenditures for different regions of the country.

 

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Source: The Hindu