A Reserve Bank of India study Monday revealed that states’ gross fiscal deficit was within the threshold of Fiscal Responsibility and Budget Management laws in the last two years, but it was possible due to sharp reduction in capital expenditure by states. The RBI’s report on States Finances: A Study of Budgets of 2019-20 said that the outstanding debt of states have risen over the last five years to 25 per cent of Gross Domestic Product, posing medium-term challenges to its sustainability.
“States’ gross fiscal deficit (GFD) has remained within the FRBM threshold of 3 per cent of gross domestic product (GDP) during 2017-18 and 2018-19. This has, however, been achieved by sharp retrenchment in expenditures, in particular, capital expenditure. For 2019-20, states have budgeted for a consolidated GFD of 2.6 per cent of GDP with a marginal revenue surplus (as against revenue deficits in the previous three years),” as per the report released Monday.
The report said sharp reduction in capital expenditure by states has potentially adverse implications for the pace and quality of economic development, given the large welfare effects of a much wider interface with the lives of people at the federal level. “Currently, states employ about five times more people and spend around one and a half times more than the Centre. Moreover, public expenditure by states influences the quality of physical and social capital infrastructure of the economy,” it noted.
The report said states need to combine efforts towards mobilising higher revenues with strategies to maximise efficiency gains rather than mere increase in tax rates. Unless revenues pick, states will be forced to cut capital expenditure, further stoking the economic slowdown. Reduction in capital expenditure can feed an ever-tightening vicious spiral of austerity deepening the economic downturn which, in turn, cramps fiscal revenues and forces further expenditure reductions and so on.
“States’ revenue prospects are confronted with low tax buoyancies, shrinking revenue autonomy under the GST framework and unpredictability associated with transfers of IGST and grants. Unrealistic revenue forecasts in budget estimates thereby leave no option for states than expenditure compression in even the most productive and employment-generating heads,” it said. It noted that states need to gradually harness the GST database to expand the tax base. They also need to review their tariff policies relating to power and irrigation, keeping in mind the break-even user charges.
The report also warned about risk of off-budget liabilities in the form of guarantees mutating into a contingent risk to debt sustainability even as structural bottlenecks in power distribution continue to foster. States may have to take over higher losses of power distribution companies if they do not show a turnaround in their performance.
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