State Fiscal Prudence

Syllabus: Economy

Source: TH

Context: The Reserve Bank of India (RBI) released its report on state finances, highlighting the fiscal performance of Indian states.

RBI Data on State Fiscal Condition:

• Gross Fiscal Deficit (GFD): States contained GFD within 3% of GDP in 2022-23 and 2023-24; budgeted at 3.2% for 2024-25.

• Revenue Deficit: Limited to 0.2% of GDP in 2023-24.

• Capital Expenditure: Increased from 2.4% of GDP in 2021-22 to 3.1% budgeted for 2024-25.

• Outstanding Liabilities: Declined from 31% of GDP (March 2021) to 28.5% (March 2024), yet above the pre-pandemic level of 25.3%.

What is Fiscal Prudence?

• Definition: Fiscal prudence refers to the responsible management of public finances, focusing on controlling deficits, maintaining sustainable debt levels, and prioritizing productive expenditure.

Reasons Behind the Lack of Fiscal Prudence Among States:

• Populist Schemes: States like Punjab and Andhra Pradesh face financial strain due to free electricity, water subsidies, and farm loan waivers, impacting long-term fiscal sustainability.

E.g. Punjab’s free electricity scheme for farmers increased the state’s subsidy burden in 2023.

• Rising Debt Levels: Over-dependence on borrowing for capital and revenue expenditures.

E.g. West Bengal’s debt-to-GDP ratio remained at 35.5% in 2023, well above the FRBM limit.

• Off-Budget Borrowings: Use of off-budget mechanisms such as guarantees and loans by state PSUs creates hidden liabilities.

E.g. Andhra Pradesh in 2023 faced scrutiny for ₹55,000 crore off-budget borrowing.

• Delay in Fiscal Reforms: Resistance to implementing reforms such as property tax increases or disinvestment.

E.g. Rajasthan deferred property tax hikes in 2024 due to political opposition.

• Dependence on Central Grants: States often rely on the Centre rather than building self-sustained revenue mechanisms.

E.g. Northeastern states relied heavily on central funds in 2023, limiting fiscal autonomy.

Initiatives to Achieve Fiscal Prudence:

• State-Specific Fiscal Responsibility Legislations (FRLs): Legal framework for fiscal discipline. Monitoring Off-Budget Borrowings: Enhanced reporting and transparency. Encouraging Counter-Cyclical Fiscal Policies: Advocating expenditure and savings based on economic cycles.

• State-Specific Fiscal Responsibility Legislations (FRLs): Legal framework for fiscal discipline.

• Monitoring Off-Budget Borrowings: Enhanced reporting and transparency.

• Encouraging Counter-Cyclical Fiscal Policies: Advocating expenditure and savings based on economic cycles.

• Government:

• 14th and 15th Finance Commissions: Recommendations for fiscal consolidation and debt sustainability. Debt Consolidation Roadmaps: Specific targets for states. Increased Capital Allocation: Promoting growth-enhancing spending. Subsidy Rationalization: Programs to optimize welfare expenditures.

• 14th and 15th Finance Commissions: Recommendations for fiscal consolidation and debt sustainability.

• Debt Consolidation Roadmaps: Specific targets for states.

• Increased Capital Allocation: Promoting growth-enhancing spending.

• Subsidy Rationalization: Programs to optimize welfare expenditures.

Challenges to Fiscal Prudence in Indian States:

• Rising Subsidies: Increased reliance on populist measures.

• High Contingent Liabilities: Off-budget borrowing and guarantees strain finances.

• Revenue Deficits: Poor tax administration and dependency on Central grants.

• Debt Overhang: Liabilities remain above pre-pandemic levels despite recent reductions.

Way ahead to achieve fiscal prudence:

• Adopt Risk-Based Frameworks: Implement counter-cyclical policies for financial resilience.

• Debt Consolidation Roadmap: Set clear, time-bound targets for reducing liabilities.

• Enhance Revenue Sources: Improve state tax administration and rationalize subsidies.

• Transparency in Borrowings: Ensure strict reporting of off-budget liabilities.

• Focus on Growth-Enhancing Expenditure: Prioritize capital spending to boost economic growth.

Conclusion:

The 15th Finance Commission’s recommendations and RBI’s insights serve as crucial guidelines for achieving sustained fiscal prudence in Indian states. Adopting comprehensive fiscal reforms is essential to balance developmental needs and fiscal sustainability.

Insta Links:

• Fiscal prudence

• Distinguish between Capital Budget and Revenue Budget. Explain the components of both these Budgets. (UPSC-2021)

• Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments. (UPSC-2019)