Union government – not states – must get its finances in good shape

In its annual report ‘State Finances: A Study of Budgets of 2024-25’ published earlier this month, the Reserve Bank of India (RBI) grudgingly called the improvement in ‘post pandemic state finances’ ‘commendable’. Still, the RBI offered the states a long list of advice for attaining ‘durable fiscal consolidation’.

The first area of concern the RBI underlined is ‘incipient stress in the sharp rise in expenditure on subsidies, driven by farm loan waivers, free/subsidised services (like electricity to agriculture and households, transport, gas cylinder) and cash transfers to farmers, youth and women’.

Many state governments have launched new cash transfer schemes. Most free/subsidised schemes (freebies) have also persisted.

What is the state of the states’ finances? Is their fiscal consolidation under threat? Do they need a new fiscal consolidation roadmap?

Strong fiscal consolidation

The RBI report confirms that states’ aggregate fiscal deficit has been below 3% of the GDP in 14 of the 17 years since 2006-2007; of these 14, three times they were less than 2%. In 2015-2016, the states’ fiscal deficit was 3.1% and in 2016-2017 it was 3.5%; still, these two were within the enhanced ceiling of 3.5%.

Only in 2020-2021, when the GDP contracted, tax revenues slumped and the Union government ran a fiscal deficit exceeding 9%, the states’ fiscal deficit turned out to be 4.1%.

The fact that the states have consistently managed to keep fiscal deficits well within the limit for so long is sufficient evidence of their ability to keep their fiscal house in order.

Subsidies within leash

The RBI report further informs that states’ expenditure on subsidies went up from Rs 1.87 trillion in 2018-2019 to Rs 4.44 trillion in 2022-2023, recording a compounded annual growth rate (CAGR) of 24.07%.

The states’ total expenditures during this period grew from Rs 33.38 trillion to Rs 47.93 trillion at a CAGR of 9.47%. The expenditure on subsidies grew two-and-a-half times.

The developmental and non-developmental expenditures, which include subsidies, recorded a lower CAGR of 8.83% and 8.94% respectively during this period. It is the remaining category of ‘others’ (which includes transfers to local bodies and repayment of Union government loans) which recorded a higher CAGR of 15.23%.

Surely, the states kept their subsidies within the larger expenditure leash.

The performance of individual states, however, differed. Some states recorded a very high CAGR, like Tamil Nadu (58.85%) and Andhra Pradesh (58.09%). Some could keep subsidy expenditures stagnant, like Haryana (2.29%). Even fiscally-stressed states succeeded in putting a squeeze on subsidies, like Punjab (10.84%) and Rajasthan (4.98%).

There is nothing in the states’ aggregate or individual behaviour to be alarmed about. A transformation of expenditure composition is underway. The states which announced cash transfer schemes in 2023-2024 and 2024-2025 would also manage without compromising overall fiscal stability.

Capital expenditures grows

At Rs 4.6 trillion in 2019-2020 the states’ capital expenditures amounted to 2.3% of the GDP. Despite big stress on their fisc, the states managed to keep capital expenditures at 2.3% of the GDP in the pandemic year 2020-2021.

Thereafter, their capital expenditures (as a proportion of the GDP) have been rising only — 2.4% in 2021-2022, 2.5% in 2022-2023, and 2.8% in 2023-2024 (provisional estimates).

While a lot can be said about the productivity of the states’ capital expenditures, nominally, their performance on this front cannot be faulted.

States’ debt too high for comfort?

The RBI is worried about ‘the persistent high level of sub-national debt’, which in its assessment ‘calls for a credible roadmap of debt consolidation’. The states’ debt consolidation has been going on for more than three decades with most of the battle waged successfully in the first decade.

The states’ outstanding debt and liabilities to the GDP ratio was 28.9% in 2007. A laser-sharp focus on fiscal deficits in the next eight years brought this down to 21.7% in 2015.

Thereafter, during the reign of the BJP government at the Centre and in many states, the ratio started rising and reached 26.6% in 2020. In the Covid-19 year of 2021, with nominal GDP contracting, the states’ debt-to-GDP ratio peaked at 31%.

With fiscal deficits under control, thereafter, there is a consistent downward trend bringing the debt-to-GDP ratio to 28.2% in 2023.

Only a formality

There is no need for drawing up any fresh roadmap of debt consolidation as the RBI has called for. The states need only to ensure that they keep their fiscal deficits lower than 3% of the GSDP. The debt-to-GDP ratio will take care of itself in due course.

For this, the states will have to avoid the temptation of an additional 0.5% fiscal deficit, allowed by the Union government for taking its interest-free capital expenditure loans. If some states want to take the benefit of these loans, they may forego other borrowings to that extent.

It is more likely that most states will undertake new direct cash transfer schemes in times to come. They may do it if they limit new expenditures to either additional revenues or substitute other expenditures.

The finances of India’s states are in a good shape. It is the Union government’s finances which need to get in shape.

(Subhash Chandra Garg is former Finance & Economic Affairs Secretary, and author of ‘The Ten Trillion Dream’ and ‘We Also Make Policy’.)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.