Fiscal consolidation: States lack the flexibility that the Centre enjoys

While the Centre has an escape clause to deviate from the fiscal consolidation road map by 0.5 percentage point of GDP in times of exigency, states were not given any such escape clause

While the Centre has relaxed its fiscal deficit target for the current financial year to 9.5 per cent of India’s gross domestic product (GDP), much higher than the escape clause allowed by the previous Fiscal Responsibility And Budget Management (FRBM) Act, states got the Centre’s approval to increase it to five per cent of their respective gross state domestic product (GSDP) from the targeted three per cent, subject to some riders.
 
While the Centre was given an escape clause to deviate from the fiscal consolidation road map by 0.5 percentage point of GDP in times of exigency, states were not given any such escape clause. It is another matter that even 0.5 percentage point escape clause proved minuscule when the Covid-19 induced lockdowns hit the economy. In fact, even states got much higher leeway than this from the Centre for 2020-21. However, states do not have such in-built flexibilities; the Centre grants them permission.

 
For 2020-21, states got the Centre’s permission to widen their fiscal deficit beyond three per cent to up to five per cent of GSDP. However, while the 0.5 percentage point was unconditional, one percentage point was subject to meeting some reform requirements, including the ‘one nation one ration card’, power reforms, etc. The remaining 0.5 percentage point was also permitted if states carried out at least three of the four reforms listed. This was altered a bit when the issue of compensating states for lacklustre goods and services tax (GST) collections emerged.
 

This issue of lack of symmetry between the Centre and states was raised by 15th Finance Commission Chairman N K Singh at a recent event. He said the central government could trigger escape clauses on account of exigencies. It could take Parliament's approval for deviation from the fiscal road map. "No similar arrangement or device is available to states," he said.

 
Singh also said that the 15th Finance Commission in some ways sought to mitigate this by recommending a fiscal range for states instead of committing them to a fixed fiscal point.
 
The Finance Commission recommended a range of three per cent to 4.5 per cent of states’ respective GSDP for the purpose of state fiscal deficit for 2021-22. Of this, 0.5 percentage point was linked with power sector reforms. For the next year, the range given is three-four per cent of GSDP, with the same condition for power sector reforms. The range would be three-3.5 per cent for the next two years, with 0.5 percentage point being linked to power sector reforms. For the terminal year, the fiscal deficit recommended is 3 per cent of GSDP for states.

 
However, former chief statistician Pronab Sen said: "This is a little bit of an eyewash." That is so because Article 293 of the Constitution says that a state will have to take the permission of the Centre for borrowings if it has any outstanding liabilities with the Centre or the Centre has guaranteed any of its loans.
 
Former director of the National Institute of Public Finance and Policy Govinda Rao said the very fact that action-taken report on the 15th Finance Commission said that the Centre had accepted the recommendations in relation to the fiscal deficit path of states meant that these recommendations would be implemented.

 
Singh also said that the arrangement of symmetry in powers between the Centre and states needed to be formalised as we went forward.
 
According to Rao, states will have to amend their FRBM Acts and put escape clauses there.
 
In fact, the N K Singh-headed FRBM review committee had given a fixed point for fiscal deficit targets even for the Centre. It had recommended that the Centre rein in the deficit at three per cent during 2017-18 and keep it there till 2019-20. After that, the Centre could control the deficit at 2.8 per cent in FY21, 2.6 per cent in FY22 and 2.5 per cent in FY23. But it gave an escape clause of 0.5 per cent for the Centre to deviate from these targets. This clause could be triggered in any of the following conditions:

 
i) Overriding considerations of national security, acts of war, calamities of national proportion, and collapse of agriculture severely affecting farm output and incomes,
ii) Far-reaching structural reforms in the economy with unanticipated fiscal implications,
iii) Sharp decline in real output growth of at least 3 percentage points below the average of the previous four quarters
 
It is another matter that these targets now seem quite ambitious. Even in 2019-20, the government's fiscal deficit was initially targeted at 3.3 per cent. Even on this, the government triggered an escape clause on the ground that corporation tax rates had been drastically reduced that year and projected the deficit to be 3.8 per cent. Even this escape clause did not matter later as the deficit actually turned out to be 4.6 per cent of GDP that year. This year is a bit of an exception as the government has had to loosen its purse strings to deal with the circumstances created by Covid 19-induced lockdowns. On top of that, the government came upfront and revealed its food subsidy. The deficit was initially pegged at 3.5 per cent of GDP for the current financial year, but the Budget for 2021-22 revised it to 9.5 per cent.

 
These flexibilities do not exist automatically for states, which have to rein in their fiscal deficit to the extent that their market borrowings do not cross three per cent of their respective GSDPs. As cited above, the Centre did give some flexibility to states – up to 5 per cent of GSDP, some part of that with riders.
 
Singh defended this arrangement, which takes its power from Article 293 of the Constitution. “Now this is quite understandable. Because, after all, the overall macro stability of the general government is the obligation under the Constitution of the central government alone," he said.

 
But Singh added that the symmetry in the recourse the central government could take additional flexibility was not available to states. "We need, therefore, to consider that as we look to a newer framework," he suggested.