RBI releases Study on State Finances 2009-10

RBI releases Study on State Finances 2009-10

The Reserve Bank of India (RBI) today released "State Finances: A Study of Budgets of 2009-10", a publication that provides data, analysis and assessment of finances of State governments.

The State governments have formulated their budgets for 2009-10 against the background of the knock on effect of global financial crisis on the Indian economy.  To address the overall macroeconomic slowdown, the Central Government allowed the States to raise additional market borrowings to the extent of 0.5 per cent of GSDP during 2008-09 and increase the limit of fiscal deficit to 3.5 per cent of GSDP for undertaking capital expenditure, thereby providing them additional fiscal space. Further in the Union Budget 2009-10, States have been allowed to raise additional market borrowings of 0.5 per cent of GSDP, thus increasing the limit of GFD to 4.0 per cent of GSDP during 2009-10.

The major findings of the Study are as follows:

• The consolidated fiscal position of the State Governments indicates that the process of fiscal correction and consolidation experienced a slippage in 2008-09 (Revised Estimates) on account of overall macroeconomic slowdown following the global financial crisis. The key deficit indicators are as follows:
• The Gross Fiscal Deficit (GFD) is budgeted to increase to 3.2 per cent of GDP in 2009-10 (Budget Estimates) as compared with 2.6 per cent of GDP in 2008-09 (RE).
• Revenue account turned from a surplus of 0.2 per cent in 2008-09 (RE) to a deficit of 0.5 per cent of GDP in 2009-10 (BE).
• Disaggregated level fiscal indicators reveal that most of the States are faced with deterioration in revenue balance and increase in the level of GFD. State-wise, revenue account of four States, viz., West Bengal, Punjab, Kerala, and Rajasthan recorded revenue deficit during 2008-09 (RE). Jharkhand turned from revenue deficit to revenue surplus State.  In 2009-10 (BE), 10 States are expected to show revenue deficit from surplus in the previous year. Overall, revenue account is expected to be adversely impacted in case of 23 States during 2009-10 (BE).
• Number of States with GFD-GSDP ratio of less than 3.0 per cent decreased from 18 in 2007-08 (Accounts) to 9 in 2008-09 (RE) and 6 in 2009-10 (BE). GFD is estimated to exceed 3.0 per cent of GSDP during 2009-10 (BE) in States like Maharashtra, Madhya Pradesh, Andhra Pradesh, Rajasthan, Haryana, Orissa, Jharkhand, Uttar Pradesh, Punjab, West Bengal and Goa. However, despite the slowing down of revenue and the need for increased expenditure on account of economic slowdown, States like Kerala, Bihar, Karnataka, Chhattisgarh, Gujarat and Tamil Nadu have been successful in limiting their fiscal deficit within the TwFC target of 3.0 per cent of their GSDP during 2009-10.
• The debt-GDP ratio of State governments came down to 26.2 per cent in 2008-09 (RE) from the peak level of 32.8 per cent as at end-March 2004. However, outstanding debt is budgeted to increase marginally to 26.5 per cent of GDP at end-March 2010. The TwFC had recommended for a debt-GDP ratio of 30.8 per cent to be achieved by the States as at end-March 2010.
• As against the TwFC target of interest payment to revenue receipts (IP-RR) ratio of 15 per cent to be achieved by 2009-10, the combined IP-RR ratio of the States declined from 26.0 per cent in 2003-04 to 14.4 per cent in 2008-09 (RE). IP-RR ratio is budgeted to rise marginally to 14.5 per cent in 2009-10.
• On reform side, few State governments that have announced fiscal stimulus packages envisages higher spending and lower tax rates for certain sectors in order to boost aggregate demand. An additional factor that is likely to influence the State finances during 2009-10 but having positive implications for aggregate demand is the implementation of Sixth Central/States’ Own Pay Commission.
• The State governments account for around 60 per cent of the combined expenditure of Centre and States reflecting the vital role of States in growth and development of the economy. Compression in consolidated expenditure of State governments can be observed during 2005-10 period mainly on account of some rationalisation of revenue expenditure during the FRL period. This is evident from the decline in Revenue Expenditure-GDP ratio from 13.3 per cent in 2000-05 to 12.4 per cent during 2005-10. Empirical exercise indicated convergence of the major components of the development expenditure across the States.

Report suggested that, States may consider strengthening the rule based formula by incorporating elements which inter alia may include counter-cyclical fiscal policy framework, setting up of fiscal stabilisation fund, a target for debt-GSDP and interest payments-revenue receipts with a view to attaining debt sustainability. In addition, a rule may be prescribed for primary revenue balance (PRB), i.e., PRB should be in surplus and adequate enough to meet interest payments of the States. Furthermore, numerical targets in respect of certain categories of expenditure such as, non-interest revenue expenditure with sub-targets for revenue expenditure on social services and on economic services; institutional reforms such as common budgetary practices, transparency rules, accounting system, public expenditure management and outcome budgeting; and independent audit mechanism and transparent oversight and monitoring have been suggested. States may also attempt to avoid build-up of cash surplus by adopting advanced forecasting and monitoring mechanism keeping in view the best practices across advanced economies.

The Study highlights that, the fiscal correction and consolidation witnessed in State finances in the recent past is likely to have a setback in 2008-09 (RE) due to the economic slowdown and the accompanying moderation in the pace of revenue growth. The Study emphasises that the States need to successfully manage the transition with regard to the implementation of award of the Sixth Central/States' Pay Own Commission. In addition, there are certain structural issues that continue to remain important for State finance, such as quality of expenditure and surplus in cash balances of the State governments. With experience gathered through their FRLs, States need to plan the next round of reforms and resume the process of fiscal correction and consolidation at the earliest.

The publication has been prepared in the Division of State and Local Finances (DSLF) of the Department of Economic Analysis and Policy. Starting with 2001-02, this publication is available at RBI website (www.rbi.org.in). Comments on this publication may be sent to Director, Division of State and Local Finances, Department of Economic Analysis and Policy, Reserve Bank of India, Shahid Bhagat Singh Road, Mumbai 400 001. Comments can also be sent via email. 

Alpana Killawala

Chief General Manager