States’ financial position needs to be watched as much as the Centre’s

The Centre met its fiscal deficit target once in 2007-08 but could never achieve its revenue deficit target. (Representative image)

In recent months, there has been a growing concern over the financial health of Indian state governments. The Prime Minister has been raising concerns over the worsening of state finances and has cautioned them against distributing revadis or freebies. Despite these concerns, we continue to see some political parties promising more revadis on being elected.

In 2003, the central government implemented the Fiscal Responsibility and Budget Management (FRBM) Act. Under FRBM, the central government will target to reduce its fiscal deficit to 3 percent of GDP and eliminate the revenue deficit. In the period 2005-20, the average of the two deficit targets shows how far the Centre has been from the target. The Centre met its fiscal deficit target once in 2007-08 but could never achieve its revenue deficit target.

In 2005, the FRBM Act was mirrored by states in form of the Fiscal Responsibility Legislation (FRL). States have done a much more reasonable job of meeting their targets, as shown in the table. They not only maintained fiscal deficit targets but also managed to eliminate revenue deficits. In fact, the states actually ran revenue surpluses for seven years. The Reserve Bank of India notes that before the pandemic, states crossed the FRL threshold of 3 per cent of gross domestic product (GDP) in just three years. In 2009-10, it was due to the global financial crisis, in 2015-16 and 2016-17 it was due to the implementation of the Ujwal DISCOM Assurance Yojana (UDAY).

The pandemic changed the fiscal situation across the world. Tax revenues declined and expenditures rose sharply. India was no different and there was a significant rise in both fiscal and revenue deficits of the central government (table).

The deficits also rose sharply at the state level with fiscal deficit averaging 4 percent and revenue deficit averaging 2 percent in 2020-22. The aggregate picture hides the deficits at the individual state level where the situation has become alarming for some states (figure 1). Eighteen states including union territories have a higher fiscal deficit than the average of all states/UT. Even if we exclude the northeastern states and UTs, we see many large states having high deficit levels. Only five states and UTs have fiscal deficits lower than the FRL target of 3 percent: Maharashtra, Puducherry, Gujarat, Arunachal Pradesh and NCT Delhi.

Another indicator which reflects the long-term fiscal outlook situation is outstanding liabilities or debt levels. Deficits occur annually whereas debt levels are cumulative over a period. The government amended FRBM Act in 2018 where it again promised to achieve a fiscal deficit target of 3 percent but excluded the target on revenue deficit. However, the government added a target of keeping debt levels of the General Government which includes the Centre and states at 60 percent of GDP. Within general debt levels, it fixed the central government debt level at 40 percent of GDP, meaning states’ level debt was restricted to 20 percent of GDP. If we use 20 percent debt as a target, we see all states/UTs having higher debt levels barring Delhi and Maharashtra. The debt levels of Punjab, Himachal Pradesh and Rajasthan are above 40 percent of GSDP.

There is another interesting aspect about some of these states having a high deficit and high debt levels. We saw political parties promising the so-called revadis to people during election campaigns in these very states! The promises included free electricity and a return to the old pension scheme (OPS) in Himachal Pradesh, Gujarat and Rajasthan. After winning elections in Himachal Pradesh, the new chief minister Sukhwinder Singh Sukhu announced at the first cabinet meeting that his government will implement the OPS.

The reversion to OPS is regressive for two reasons. First, it threatens to undo the reforms initiated by the new pension scheme, which was ironically supported by the Congress party at the Centre. As per research by Deepak Mohanty, the annual rates of return on various NPS schemes since inception was in the range of 9.0-12.7 percent and have been very competitive vis-à-vis alternate saving instruments besides offering the primary benefit of steady income. Second, the OPS will further worsen the already precarious financial conditions of these states.

To sum up, most economists pay attention to the fiscal situation at the Centre level but there is a need to focus on the state finances as well. The aggregate financial position of states may look manageable but when we look at individual states, the position looks weak. There are reports suggesting some of these states are nearly bankrupt. While governments do not become bankrupt like corporations, the point about the condition of fiscal health in state governments needs serious attention and action.

Amol Agrawal is faculty at Ahmedabad University. Views are personal and do not represent the stand of this publication.