Based on the recommendations of the Eleventh Finance Commission, the ministry has been withholding 15 per cent of the revenue deficit grants which the state is entitled to unless certain fiscal targets are met.
These grants are being released only when the fiscal targets on deficit are met by the states. The move, in principle, is unexceptionable. However, a close look at the operation of the scheme reveals that it is farcical and that the Ministry of Finance is penalising the states for its own inefficiency.
The broad conditions imposed were that all states should collectively reduce the gross fiscal deficit of the states as a percentage of Gross State Domestic Product by 2.5 per cent, the revenue deficit should drop to zero, and interest payment as a proportion of revenue receipts should drop by 18 to 20 per cent.
Within this macro guideline, the ministry set out a simple one rule formula. The operational part of the MTFRP was that the release of these 15 per cent revenue deficit grants was based on a single monitorable fiscal objective that each state will achieve a minimum improvement of 5 per cent in the revenue deficit as a proportion of their revenue receipts each year till 2004-05.
The improvement was measured from the base year of 1999-2000. Within these broad guidelines, each state signed a Memorandum of Understanding with the Ministry of Finance for release of the withheld grants and a commitment of serious fiscal reforms.
Achieving these targets, which by any yardstick are stringent, would have required a very severe expenditure compression and a very ambitious resource raising effort on the part of the states. To the extent that this is possible, the states should have made efforts to achieve these targets.
However, some basic and practical facts have been ignored which has meant that no state has been able to meet these targets in reality. On paper, a number of states may have shown an improvement but in reality there has been no fiscal compression.
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