Macro Perspective on the Fiscal Health of States in India : Daily News Analysis

Date : 06/07/2023

Relevance: GS Paper 3 : Economy- Fiscal policy

Keywords: Fiscal deficit, Debt-to-GSDP ratios, Revenue deficit, Fiscal stability

Context -

Understanding the fiscal health of states in India is crucial, considering their significant role in revenue mobilization, government expenditure, and borrowing. An analysis of key data from individual state budgets for 2023-24 provides insights into the emerging fiscal situation.

Fiscal Policy

To generate revenue and to increase expenditures, the government finance or policy is called Budgeting policy or fiscal policy.

What is FRBM Act?

It was enacted in August 2003.
It aims to make the Central government responsible for ensuring inter-generational equity in fiscal management and long-term macroeconomic stability.
The Act envisages the setting of limits on the Central government’s debt and deficits.
It limited the fiscal deficit to 3% of the GDP.
To ensure that the States too are financially prudent, the 12th Finance Commission’s recommendations in 2004 linked debt relief to States with their enactment of similar laws.
The States have since enacted their own respective Financial Responsibility Legislation, which sets the same 3% of Gross State Domestic Product (GSDP) cap on their annual budget deficits.
It also mandates greater transparency in fiscal operations of the Central government and the conduct of fiscal policy in a medium-term framework.
The Budget of the Union government includes a Medium-Term Fiscal Policy Statement that specifies the annual revenue and fiscal deficit goals over a three-year horizon.
The rules for implementing the Act were notified in July 2004. The rules were amended in 2018, and most recently to the setting of a target of 3.1% for March 2023.
The NK Singh committee (set up in 2016) recommended that the government should target a fiscal deficit of 3% of the GDP in years up to March 31, 2020, cut it to 2.8% in 2020-21 and to 2.5% by 2023.

Relaxation under the FRBM Act

Escape Clause:

Under Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target citing certain grounds.

National security, war

National calamity

Collapse of agriculture

Structural reforms

Decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.

Fiscal Imbalance and Consolidation:

Amidst the COVID-19 pandemic, both the Union and state governments have made significant fiscal corrections, leading to a reduction in fiscal deficits.
The Union's fiscal deficit declined from 9.1% to 5.9% of GDP, while state fiscal deficits decreased from 4.1% to 3.24% of GDP.
Major states are expected to achieve a fiscal deficit of 2.9% of GDP in 2023-24. However, an aggregated view of general government finances is currently unavailable, and analyzing individual state budgets provides valuable insights.

Fiscal Challenges:

While states have managed to contain their fiscal deficits, there are significant challenges that need to be addressed, particularly concerning revenue deficits.
Out of 17 major states, 13 have revenue deficits in the 2023-24 budget. Seven states, namely Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal, have revenue deficits driving their fiscal imbalances.
These states also have high debt-to-GSDP ratios, indicating the need for corrective measures.

Importance of Revenue Deficit Consolidation:

While the presence of a revenue deficit doesn't necessarily indicate fiscal profligacy, it has long-term implications and needs correction.
Specific shares of revenue deficit in fiscal deficit for these seven states range from 39.7% to 70.7%. The overall revenue deficit in fiscal deficit for all states is expected to be 27% in 2023-24.
Addressing the revenue deficit is crucial for ensuring fiscal stability and supporting state-specific growth.

Framework for Revenue Deficit Consolidation:

Taking a long-term view, a framework for revenue deficit consolidation should be established.
Measures such as linking interest-free loans from the Union Government to a reduction in revenue deficit can prevent the diversion of borrowed resources to finance revenue expenditure.
Additionally, a defined time path for revenue deficit reduction and performance incentive grants can incentivize states to achieve fiscal balance and improve expenditure quality.

Conclusion:

To improve the fiscal health of states in India, it is necessary to focus on revenue deficit management. A comprehensive framework for revenue deficit reduction, including incentives and performance-based grants, can help restore fiscal balance and support state-specific growth. A macro perspective is essential to address the challenges and ensure the fiscal stability of state finances.

Probable Questions for mains exam -

Discuss the fiscal health of states in India, taking into account key indicators such as fiscal deficit, debt-to-GSDP ratios, and revenue deficits. Analyze the implications of revenue deficits on the overall fiscal stability of states and their ability to support economic growth. Propose a framework for revenue deficit consolidation, including measures to incentivize states and ensure the effective management of borrowed resources. (10 Marks,150 Words)
Evaluate the effectiveness of the Fiscal Responsibility and Budget Management (FRBM) Act in ensuring fiscal discipline and inter-generational equity in the management of government finances at both the central and state levels in India. Assess the impact of the FRBM Act on the reduction of fiscal deficits and the promotion of long-term macroeconomic stability. (15 marks,250 Words)

Source : The Hindu