New Delhi: Prime Minister Narendra Modi’s administration approved a proposal to cap states’ budget deficits as it looks to shrink Asia’s widest shortfall.

State governments will have to limit the gap to 3% of their gross domestic product (GDP) in a financial year, Frank Noronha, the federal government’s spokesman, wrote on Twitter. The state governments can exceed the target by 0.5 percentage point if they keep interest payments and the debt-GDP ratio within specified limits.

Continued fiscal consolidation is key to protecting India’s credit rating and winning more interest-rate cuts from Reserve Bank of India (RBI) governor Raghuram Rajan. At the same time, states also need room to manoeuvre under a plan to reorganize about $5 trillion of debt piled up at power utilities.

The move to cap the states’ fiscal deficit is based on the recommendation of the finance commission, a panel that decides every five years how tax revenues should be divided between the federal and state governments. The government had earlier implemented the panel’s advice to share a record 42% of total tax collections with states instead of 32%.

Modi has been advocating for greater autonomy of states and increased coordination with the federal government to ensure faster project approvals and boost investment. Bloomberg

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