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Five states need to take steps to stabilise debt levels: RBI

 Gs Paper-3

Syllabus: Government Budgeting

 

Context:

As per the Recent RBI study, five states -Bihar, Kerala, Punjab, Rajasthan and West Bengal are highly stressed states.

 

Status of states Debt:

  • Punjab: its debt-GSDP ratio is projected to exceed 45 per cent in 2026-27
  • Rajasthan, Kerala and West Bengal: projected to exceed the debt-GSDP ratio of 35 per cent by 2026-27. These states will need to undertake significant corrective steps to stabilise their debt levels.
  • Ten states accounting for half of the total expenditure in India are Punjab, Rajasthan, Kerala, West Bengal, Bihar, Andhra Pradesh, Jharkhand, Madhya Pradesh, Uttar Pradesh and Haryana.
  • Debt/GSDP ratio definition: It is a metric that shows what a state owes with what it produces. It indicates that particular state’s ability to pay back its debts.

 

Reasons for fiscal deterioration in states:

  • Not adhering to targets set by the 15th FC: Among the ten states, Andhra Pradesh, Bihar, Rajasthan and Punjab exceeded both debt and fiscal deficit targets for 2020-21 set by the 15th Finance Commission.
  • Fall in own tax revenue: It said the own tax revenue of some of these 10 states, viz., Madhya Pradesh, Punjab and Kerala, has been declining over time, making them fiscally more vulnerable.
  • Volatile non-tax revenue: For most of these states, non-tax revenue has remained volatile, dropping significantly in recent years.
    • The decline in non-tax revenue is under general services, interest receipts and economic services.
  • High revenue expenditure: The share of revenue expenditure in total expenditure of these states varies in the range of 80-90 per cent.
    • Some states like Rajasthan, West Bengal, Punjab and Kerala spend around 90 per cent on revenue accounts. This results in poor expenditure quality, as reflected in their high revenue spending to capital outlay ratios.
    • Definition of Revenue expenditures: These include the expenses required to meet the ongoing operational costs of running the government, and thus are essentially the same as operating expenses e.g., rent, employee salary etc.
  • High committed expenditure: These include interest payments, pensions and administrative expenses, account for a significant portion (over 35 per cent) of the total revenue expenditure in states like Haryana, Uttar Pradesh, West Bengal, Kerala and Punjab, leaving limited fiscal space for undertaking developmental expenditure.
    • Consequently, the share of developmental expenditure in these states is considerably lower than in the other states.
    • Although welfare-enhancing, the impact of revenue spending on economic activity lasts for just about a year. In contrast, the impact of capital outlay is stronger and lasts longer, with the peak effect materialising after two-three years.
  • High losses of DISCOMs: After the UDAY scheme, the losses of DISCOMs were made part of state government liability. This further worsened the situation.

 

Immediate impact:

  • Impact of COVID19: It led to high expenditure and low revenue, thus misbalancing state finance
  • Impact of the Russia-Ukraine war: The high oil prices have led the states to cut duty on Petroleum, thus further impacting their revenue.

What happens if the debt-to-GDP ratio widens?

  • Each year’s borrowing (or deficit) adds to the total debt. Paying back this debt depends on a state’s ability to raise revenues.
  • If a state, or all the states in aggregate, finds it difficult to raise revenues, a rising mountain of debt — captured in the debt-to-GDP ratio — could start a vicious cycle.
  • Then, states end up paying more and more towards interest payments instead of spending their revenues on creating new assets that provide better education, health and welfare for their residents.

 

Steps taken:

  • Central government directives: The Centre has urged chief secretaries of all states to keep a check on the increasing debt burden and fiscal deficit as their performance will have a huge bearing on the country’s economy.

Other long-term measures suggested by the central government:

  • Need to adopt the best practices of other states for crop diversification: discourage more paddy and wheat cultivation, and focus on pulses and oilseeds.
  • Focus on slums redevelopment and cluster development
  • Advance urban planning for Tier II and Tier III cities
  • Urban development along the transit corridor
  • Focus on the quality of their teachers: The states have been asked to fill vacancies of teachers, train them and equip them with the latest technologies.
FRBM Act

FRBM Act (2003)

  • Aim: To make the Central government responsible for ensuring inter-generational equity in fiscal management and long-term macro-economic stability.
  • Fiscal Limits: The Act envisages the setting of limits on the Central and state government’s debt and deficits.
  • The States have since enacted their own respective Financial Responsibility Legislation, which sets the same 3% of Gross State Domestic Product (GSDP) cap on their annual budget deficits.
  • The NK Singh committee(set up in 2016) recommendation: The debt to GDP ratio should be 7% for the central government, 20% for the state governments together by the FY 2022 – 23. Fiscal deficit: By FY 2022 – 23, the fiscal deficit should be 2.5% of GDP.

 

Inst Links:

Basics: Financial Relations between centre-states: Click Here

To know more about the fiscal deterioration of states: Click here

 

Practice Questions

  1. Which of the following is/are included in the capital budget of the Government of India? (UPSC 2016)
  1. Expenditure on acquisition of assets like roads, buildings, machinery, etc,
  2. Loans received from foreign governments
  3. Loans and advances granted to the States and Union Territories

Select the correct answer using the code given below.

(a) 1 only

(b) 2 and 3 only

(c) 1 and 3 only

(d) 1, 2 and 3

Answer: D

Q. With reference to the Fourteenth Finance Commission, which of the following statements is/are correct? (UPSC CSE 2015)

  1. It has increased the share of States in the central divisible pool from 32 percent to 42 percent.
  2. It has made recommendations concerning sector-specific grants.

Select the correct answer using the code given below.

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer: A

Q.  Increasing fiscal deficit of states is a cause of worry and there is a considerable need to focus on state government finances. Analyse. (15M)

Source: Indian Express