Photo: Priyanka Parashar/Mint
Photo: Priyanka Parashar/Mint

Opinion: The urgent need for states to get fiscally fit

Even as the levers of India's development progressively shift to states, their fiscal slippage in recent years, if not reversed soon, will limit India's growth prospects

The recent report, “State Finances: A Study of State Budgets 2018" by the Reserve Bank of India (RBI) confirms what has been observed for a while; that the state of state finances is in “deep trouble" territory. Stepping back, India’s states have always had a big role to play in delivering the bijli-sadak-paani-makaan-shiksha-swasth promise. For over a decade till FY15, tax buoyancy and prudent fiscal management helped states shift a greater share of resources towards development. The share of states in development expenditure rose from about half of all development spending by the Centre and states in FY11 to over two-thirds by FY16. Increase in non-conditional transfers from the Centre post the 14th Finance Commission, also gave more autonomy to states to prioritize their spending.

Yet, even as the levers of India’s development increasingly shift to states, there has been a sharp and swift reversal of the assiduous fiscal consolidation by states over the previous decade. Observations from the RBI report confirm this.

• Revenue deficit of states was up by 50%, from 40,500 crore in FY17 to 61,100 crore in FY18. Non-development expenditure grew 22% in FY18, double the pace of the previous two years. States implementing wage increases reported a 28% growth in revenue expenditure while interest payments grew 16% driven by the market borrowing binge of recent years. As many as 15 states have reported a revenue deficit for three years in a row.

• Gross fiscal deficit (GFD) printed at 5.1 trillion in FY18 or 3.1% of gross domestic product (GDP). The 3% GFD/GSDP (gross state domestic product) threshold has been breached for three years in a row, with 19 states crossing the threshold in FY18. While a moderate GFD/GSDP of 2.6% and a revenue surplus is budgeted for FY19, the likelihood of these being overshot in an election year is more than likely.

• Overall liabilities sans guarantees grew to 24% of GDP in FY18, the highest in the last five years, driven by issuance of Ujwal Discom Assurance Yojana (Uday) bonds in FY16 and FY17, farm loan waivers and pay commission awards. The share of market borrowings could increase from 61% of GFD in FY16 to 91% in FY19. The RBI cautions on stiffening state development loans (SDL) yields, and high near-to-medium-term redemption pressure.

Importantly, the share of capital expenditure has declined since FY17 and revenue deficits have overshot budgets for longer. Also, payout of wage arrears, and interest expenses could remain stickily high and keep the states’ fiscal under some pressure in ensuing years. A swift concerted response to stem and reverse this slippage is needed and this calls for actions on multiple fronts, including the following:

1. Continued efforts to make the goods and services tax (GST) buoyant: Corrective actions since the GST was launched seem to be showing results, as reflected in an uptick in revenue recently. While the RBI report too confirms a pick-up in reported GST revenue from Q4 of FY18, GST remains a work-in-progress and relentless attention is required to make good the promise of a simple, and distortion-free indirect tax regime for states to reap revenue buoyancy benefits sustainably.

2. Unlocking resources for infra-spending through asset monetization: Earlier, CRISIL Advisory had pegged India’s infrastructure investment needs during FY18 and FY22 at 50 trillion, with states having to account for 35-40% of this. Asset monetization in sectors including state highways and power transmission could possibly help recycle capital into newer infrastructure spending without adding incremental debt, crowd-in long-term private capital and bring efficiencies in management.

3. Empowering city governments and public utilities: Municipal bonds have made a comeback with Pune, Hyderabad, and Indore tapping capital markets successfully. States should do more to empower cities to translate their economic potential into resource mobilization. Public utilities, be they electricity discoms, water utilities, transport corporations, or municipal bodies, barring exception, are in operational and financial disarray. The vicious cycle of low tariffs, poor services and institutional incapacitation needs to be tackled head-on. Differentiated tariffs, directed subsidy and universal services access ought to replace flat tariffs, universal handouts and poor services.

4. Engendering a vibrant investment climate: While some strides have been made on the “doing business" front over the years, the bar needs to be raised beyond the promise of “single-window" clearance and red carpet to large investors. Expediting structural reforms to enable timely clearances, fair and effective land acquisition, and flexible labour markets will help sustainably scale-up sluggish private investment, which is showing early signs of a pick-up. A recalibrated public-private partnership programme with judicious risk allocation, contract enforceability, and consistent policy regime can further augment resources for infrastructure creation. Accelerating investment momentum here will help foster productive jobs, and support widening of tax base sustainably.

5. Redressing agrarian stress durably through wholesome reforms: Loan waivers announced by states since 2014 amount to 1.69 trillion or roughly 14% of all incremental market borrowings by state governments during this period. The RBI attributes 40% of slippage in consolidated revenue expenditure in FY18 vis-à-vis budget to loan waivers. These provide temporary relief at best and are misdirected populism at worst and generally fail the “bang-for-the-buck" test. Durable transformation in agriculture calls for progressive policies for stable prices and market linkages, farm-level support, including on crop insurance, farm inputs, soil and crop advice, and investments in logistics, irrigation, and food processing. The costly loan waiver band-aids are no substitute for the hard yards required.

To conclude, financially empowered and fiscally sound state governments are a prerequisite to lift India’s growth trajectory sustainably. The path to attaining that is anything but easy. States will need to tackle the headwinds with speed, resolve and responsibility. The time for states to get their act together on the fiscal front is now.

Anand Madhavan is director, CRISIL Infrastructure Advisory.

Comments are welcome at