The fiscal policy has remained accommodative in the post pandemic period. The stipulated fiscal deficit-GDP ratio envisioned for the State governments is 3.5 per cent of GSDP. This increase in the threshold ratio from 3 per cent of GSDP fiscal rule to 3.5 per cent is welcome, given the extra borrowing space of 0.5 per cent is tied to power sector reforms by the State DISCOMs. The RBI data showed that the combined States’ gross fiscal deficit (GFD) contained at 2.8 per cent of gross domestic product (GDP) for 2023 fiscal year, and pegged at 3.1 per cent of GSDP for 2023-24.
The fiscal rules also stipulates to eliminate the revenue deficit, which is the “golden rule” of Fiscal Responsibility and Budget Management (FRBM) Act. The golden rule articulates that the stability of the revenue receipts should be the basis for revenue expenditure design, so that the entire borrowing can focus on capital expenditure which is productive in nature. From this perspective, the government has articulated that high deficits and debts are required for capital formation in the economy in the post pandemic fiscal space. Though the revenue deficit has not been phased out entirely, the capital outlay has hovered around 2.9 per cent of GDP. The 50-year interest free capex loans from the Centre has helped in reducing States’ interest burden and provided fiscal space for heavy lifting in terms of capex.
The States are equal partners in the path towards Viksit Bharat 2024 and continued fiscal transfers from the Centre - to support public investment at the State level is very crucial. The revenue expenditure has been declining over the years in the post pandemic period, with fiscal consolidation measures. The State governments I general has not deviated from the fiscal consolidation path.
The public-debt to GSDP ratio of the States declined to 27.6 per cent of GDP for 2023-24 from the peak of 31.0 per cent in March 2021. However, there are a few States with relatively higher debt-GSDP ratio with more than 30 per cent of GSDP. The States are in general on the path of fiscal consolidation. However, if the fiscal consolidation is achieved through fiscal austerity measures (expenditure cuts) than increase in the tax buoyancy, the quality of fiscal consolidation will suffer and can affect the growth path envisioned for Viksit Bharat 2047
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The tax buoyancy has been good in the post pandemic period, especially from GST. The tax efforts of the States are laudable. However, there is scope for further reforms in the “nontax revenue” including user charges and mining revenue.
The financing pattern of deficits is a matter of significance. The predominant form of financing deficit is through market borrowings. On average, net market borrowings financed more than half of the consolidated fiscal deficit of States till 2016-17. The reliance on net market borrowings rose to more than 90 per cent in 2019-20. Thereafter, the RBI noted that States’ dependency on net market borrowing has declined and that of loans from the Centre has increased. During 2023-24, States have budgeted to finance 76 per cent of GFD through net market borrowing. If you examine the debt maturity pattern, around 30 per cent of securities are long term in the 10-year maturity securities. The rest 70 per cent was spread across maturities, ranging between 2 and 35 years. However, there is no rollover risk.
Given the high interest rates, the public debt management is getting costlier. The Finance Minister has articulated to central bank regarding the reduction of interest rates for economic growth recovery process through enhanced credit deployment and increased public investment to “crowd in” private investment. However, given the polycrisis and geopolitical uncertainties, the RBI is cautious in reducing the interest rates. The high interest rates affect the debt servicing. The debt service ratio, measured in terms of interest payment to revenue receipts (IP-RR), saw a sharp increase in the post pandemic period.
Recommendations
1. Fiscal consolidation path is crucial, with increased tax buoyancy and not through significant fiscal austerity measures through expenditure compression.
2. Reduction in revenue deficit to GSDP ratio, supported by buoyancy in tax and nontax revenue can help fiscal consolidation efforts.
3. Fiscal sustainability is important and therefore always keep a watch on the cost of the credit ® and the economic growth rate (g). If r>g, there are issues related to unsustainability.
4. High debt can be substantiated only if it is linked to capex formation and enhancing human capital, in times of low interest rate regime. However, as interest rate is mounting, public debt management is becoming expensive.
5. Increasing the tax effort of the States is crucial for supporting economic growth and human capital formation.
6. Increase in tax rates always result in increased revenue. Tax administration is tax policy, for emerging countries like India. Focus on e-governance and digital infrastructure in public finance is therefore significant.
7. Fiscal consolidation and power sector reforms are closely linked, as States can avail 0.5 per cent of GSDP (with fiscal deficit-GSDP ratio at 3.5 per cent) of extra borrowing space, if they engage in power sector reforms.
8. Fiscal transition and energy transition are closely correlated, and therefore State need to focus on climate change commitments.
9. The reforms relate to non-tax revenue, especially the extractive sector, needs an emphasis. The royalty regime of different minerals need a revisit.
10. Public Financial Management (PFM) reforms relate to climate change and gender equality – Climate responsive budgeting and gender budgeting – need an emphasis for fiscal transparency and accountability.
11. The hidden debt – through Off Budget Borrowing (OBB) - needs an analysis to increase budget transparency.
This was the article prepared the Confederation of Indian Industries (CII), and delivered at the first CII Public Policy Council meeting on November 27th 2024.
Lekha Chakraborty is Professor, NIPFP and Research Associate of Levy Economics Institute of Bard College, New York and Member, Governing Board of International Institute of Public Finance (IIPF) Munich.
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.