RBI study says fiscal health of states is poor

RBI study says fiscal health of states is poor

Mumbai: Days before the presentation of the Union Budget, a study by the Reserve Bank of India (RBI) has painted a grim picture of the fiscal strength of the states in the wake of the global economic downturn.

The combined fiscal deficit of India’s 28 states will likely go up to 3.2% of their gross domestic product (GDP) in the 2009-10 fiscal year, up from 1.5% in 2007-08 and 2.6% in 2008-09, the report by the banking regulator said.

Twenty-two states have budgeted a fiscal deficit ratio above their fiscal responsibility legislation target of 3% in 2009-10, noted the study, titled State Finances: A Study of Budgets of 2009-10.

The revenue deficits of the states are also expected to deteriorate significantly in 2008-09 and in 2009-10, mainly due to the extra pay doled out to state government employees, coupled with a slowdown in tax collection. Revenue deficit is expected to widen to 0.5% of the GDP in 2009-10, compared with a surplus of 0.2% in 2008-09 and a surplus of 0.9% the year before.

Given this situation, the RBI study has advised state governments that “a commitment to return to the path of fiscal correction at the earliest with quick reversibility of expansionary policies assumes importance".

The Union Budget will be tabled on 26 February.

The RBI study expressed concern about the re-emergence of revenue deficit after three years, and said concurrent government borrowing “would not lead to the creation of assets, which would have given returns in the future to service states’ debts".

It also warned the pace of fiscal correction and consolidation witnessed recently will likely suffer a setback.

The report criticized state governments for not allocating sufficient funds for capital expenditure even though they could now borrow up to 4% of their GDP—a special relaxation by the Central government against the mandated 3% to encourage capital investments and boost aggregate domestic demand.

Even with the higher borrowing limit, the states’ capital expenditure is budgeted to grow by only 2.5%, compared with a rise of 24.3% in 2008-09.

The states’ deteriorating financial situation is not surprising given the condition of the global economy, which limited the Central government’s ability to assist states with funds, said Dharmakirti Joshi, principal economist at domestic rating agency Crisil Ltd.

“The situation will likely continue in 2011 unless GST (goods and services tax) is implemented and the economic situation improves," said Joshi.

The RBI study suggested states could cut down on non-essential expenditure, set up a fiscal stabilization fund and a primary revenue balance surplus to meet their interest payments.