[Editorial Analysis] Need to focus on state government finances

Mains Paper: 3 | Economic Development

Prelims level: Government Finances

Mains level: Why there is a need to focus on state government finances?

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Context

• There is a fear that the Central government could overshoot its fiscal deficit target for FY19 as goods and services tax (GST) revenue has been falling short of target and there could be increased expenditure commitment in a pre-election year.

• Also worrying are the finances of state governments.

• As per a recent Reserve Bank of India (RBI) report on state government finances, the consolidated fiscal deficit of the state governments in FY18 was 3.1%, against the budget estimate of 2.7%.

What are the long-term observations?

• The Central government fiscal deficit has narrowed—aided by the hike in excise duty on petrol and diesel—from a high of 5.9% in FY12 to 3.5% in FY18, the state government fiscal deficit has been widening.

• The share of state governments in the combined (Centre plus state) fiscal deficit has widened from 18% in FY12 to 44% in FY18.

• Consolidated state government expenditure is around 1.4 times the size of the Central government expenditure.

• Five years ago, state government expenditure was around the same as Central government expenditure.

Lack of autonomy in revenue collection for State government

Increasing Fiscal deficit is a major setback for State Govt.

• State governments are bound by the FRBMA (Fiscal Responsibility and Budget Management Act) limiting fiscal deficit to around 3% of gross domestic product (GDP) and revenue deficit to 0%.

• On a consolidated basis, state governments had managed to keep their fiscal deficit below 3% since FY06.

• However, in FY16 and FY17, as state governments took over the debt of power distribution companies under the UDAY (Ujwal DISCOM Assurance Yojana) scheme, the fiscal deficit breached the 3% level.

• What is worrying is that fiscal deficit exceeded 3% in FY18 even after the termination of the UDAY scheme. The revenue deficit has also been widening. Revenue deficit averaged 0.3% in the last four years, worsening from an average of 0% in the five years before that.

• State governments have budgeted a narrower fiscal deficit of 2.6% and a revenue surplus for FY19.

• A surplus in the revenue account is a good indicator as it implies that borrowings will be done only for productive capex outlays and not to meet regular revenue expenditure.

• While revenue surplus looks good on paper, achievement of this target looks difficult.

Shortfall in Revenue collection and increasing the expenses

• On the revenue front, total devolvement to states from the tax collected by the Centre has increased to 42% since FY16 (earlier, 32% was transferred to the states).

• However, after including the cesses/surcharges, the share of states in the Centre’s gross tax revenue fell to 34.6% in FY18 (from 35.4% in FY15) and is budgeted at about the same for FY19.

• The introduction of GST is expected to widen the tax base and increase tax revenue in the long run.

• But, so far, the monthly collection from GST has been falling short of target.

• While states will be compensated by the Centre for the shortfall of GST revenue collection, the shortfall is nevertheless concerning.

• The recent reduction in GST rates for many items heightens concerns about revenue collection.

• State governments’ debt has risen sharply in the last few years due to the UDAY scheme, farm loan waivers and pay revisions.

• The state government debt-to- GDP ratio has risen from 21.5% in FY15 to 24%.

• While the consolidated state government debt-to-GDP ratio is lower than the Centre’s (46%), the sharp rise in the last three years is cause for concern.

Conclusion

• States need to be cautious as they get higher expenditure responsibility—and this is not going to be easy given their limited autonomy in revenue collection.

• On the expenditure front, states have to ensure that the quality of the expenditure is not adversely impacted—as reflected by the rising ratio of revenue to capital expenditure—in their bid to achieve the fiscal deficit targets.

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