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RBI's 'REPORT ON STATE FINANCES'

RBI's 'REPORT ON STATE FINANCES'

19-01-2024

Context:

The Reserve Bank of India (RBI) recently released the annual report titled ‘State Finances: A Study of Budget of 2023-24’ with a focus on 'Revenue Dynamics and Fiscal Capacity of Indian States'.

Key Findings of the Report

  1. Prudent (well-judged/wise) Fiscal Management: States' consolidated gross fiscal deficit to gross domestic product (GFD-GDP) ratio decreased by 1.3% (4.1% in 2020-21 to 2.8% in 2021-22).
  1. This decline resulted from a moderation (within reasonable limits) in revenue expenditure and an increase in revenue collection.
  2. Gross fiscal deficit (GFD) is the amount by which a government's total expenditure exceeds its revenue receipts and non-debt capital receipts (receipts that the government receives from the sale of old assets).
  1. Increased Capital Outlay: Capital outlay (capital expenditure) is projected to rise by 42.6% in 2023-24, reaching 2.9% of GDP. Capital outlay involves spending on asset creation, influencing economic output positively.
  2. States’ Total Outstanding Liabilities: The debt-to-GDP ratio of states decreased from 31% (March 2021) to 27.5% (March 2023). 
  1. Despite this, outstanding liabilities may remain above 30% of Gross State Domestic Product (GSDP) for many states.
    • The debt-to-GDP ratio measures the proportion of a country's national debt to its gross domestic product.
    • Gross State Domestic Product (GSDP) is the sum total volume of all finished goods and services produced during a given period of time, usually a year, within the geographical boundaries of the State.
  2. Support from the Centre, in the form of 50-year interest-free capex loans, aided in reducing states’ interest burden.
  1. Net Market Borrowings: States' reliance on net market borrowings decreased to 76% in the budgeted gross fiscal deficit (GFD) for 2023-24. This decline is attributed to an increase in states' loans from the Centre.
  2. Increased Tax Buoyancy: Implementation of goods and services tax (GST) resulted in enhanced tax buoyancy for the states. GST implementation contributed to greater formalization of the economy, expanding the tax base.
  1. Tax buoyancy is a key indicator used to measure the efficiency of a government's tax system. It is a measure of how responsive a country's tax revenue is to changes in its Gross Domestic Product (GDP).
  1. Committed Expenditure: It includes interest payments, administrative services, and pension. It is expected to remain at 4.5% of GDP.

Concerns Regarding State Finances

Solutions
  1. Non-tax revenues remain at around 1% of GDP, significantly lower than some countries.
  1. Revise user charges, royalties, and premiums, and explore asset monetization.
  1. Allocations for key sectors have been reduced, impacting development initiatives.
  1. Link conditional transfers to reforms, encouraging states to improve economic performance.
  1. Reverting to Old Pension Scheme would strain state finances, limiting growth-oriented expenditures.
  1. Enhance fiscal capacity for efficient service delivery and capital investment.
  1. Further provision of non-merit goods and services could jeopardize (put something at risk) fiscal consolidation.
  1. Streamline fund transfers, enhance banking arrangements, and improve cash management practices.
  1. Illegal mining poses a threat to revenue.
  1. Use Geographic Information Systems and Drone Surveys to identify and curb illegal mining activities.
  1. Inadequate progress toward climate goals.
  1. Introduce incentives for states making significant strides in achieving national climate goals.

 

Important Concepts

  1. N K Singh Committee Recommendations:
  1. The combined debt-to-GDP ratio of the center and states should be reduced to 60% by 2023 (comprising 40% for the Centre and 20% for states).
  2. The committee suggests incorporating (including) "escape clauses" allowing deviation from fiscal targets under specific circumstances like national security, acts of war, national calamities, etc.
  1. Important Non-tax Revenue Sources:
  1. Lease/sale of natural resources, such as minerals.
  2. User charges on economic/social services provided by the government, like irrigation, electricity, health, education, forestry, and wildlife.
  3. Lotteries.
  4. Interest receipts from loans extended to entities like public sector undertakings (PSUs) and local bodies.
  1. Fiscal Capacity of States:
  1. Fiscal Capacity reflects the State govt’s ability to meet expenditures through its own revenue receipts. Currently, the States finance only 58% of their revenue expenditure from their own revenue sources.
  2. Factors contributing to Fiscal Capacity include lower share of agriculture GSDP, high per capita income, high education levels, low inflation, low corruption, and lower size of the shadow economy.

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