TCA Srinivasa-Raghavan: The state of the states

OKONOMOS

Once upon a time, excellent research used to emanate only from the universities and to some extent from the Planning Commission. Then university research went into decline and in came the think tanks in the 1980s to fill the emerging void.

But from about the early 1990s, most think tanks have begun to tank and are now in terminal decline for exactly the same reason as university research went into decline: they pay their economists too little. So those looking for good research had to begin looking for other sources. The Reserve Bank of India stepped into the breach to some extent, which was not surprising.

What is surprising, however, is the emergence of privately-funded research, such as that coming from the rating agencies, investment banks and so on. Not much of it is available in the public domain but what little I have seen is rather good. Again not surprising, considering how much more they pay than the think tanks.

The latest is a three-part report by rating agency Fitch: India on state finances*. The first part deals with the Indian federal scheme and the financial arrangements thereof. The second is about the budgetary performance of the states. The third is about their debt.

After observing that state finances have been a mess for years, the report says "while it is much too early to proclaim the reforms launched by the Twelfth Finance Commission (TFC) an unqualified success, early evidence suggests that there are reasons to be hopeful."

The report thinks VAT is going to be a major factor, not to mention the transfers that are due as a result of the TFC. But revenue, thanks to the gap-filling approach by any name, has never really been the major problem. Expenditure has.

Here the report is out on a wing and a prayer. It hopes that the "bleeding on the expenditure front will be stemmed by recent pension sector reforms, the expected moderation of the interest bill over the medium term as a result of the recent debt relief scheme by the Centre and the secular downturn in interest rates since 2000 and power sector reforms."

The real problem for the states is the wage bill "" now soon to balloon when the new pay commission wades into public finances "" and the report says "state expenditure on salaries and the extent of the states' debt remain causes for concern." Cause for concern? Panic would be more like it.

The third report in this series, about debt, points out that "India's states have the dubious distinction of being among the most highly leveraged sub-nationals in the world." The 1990s have been especially bad in this regard.

Indeed, so bad is the situation that the TFC was obliged to recommend that all further central lending to the states stop so that they would be forced to borrow from the market, which, insha-allah, would enforce some fiscal discipline.

But this, says the report, has been happening anyway, not recently, but for 15 years! "Over the last 15 years states have increasingly approached the market to raise resources. In addition, there has been a sharp decline in the proportion of loans from the centre, primarily on account of the reclassification of loans from small savings funds."

But perhaps the most significant change has been the off-budget borrowings by the states. One cannot help wondering if anyone has any idea how much these really are, apart, of course, from the obvious subsidies to power and irrigation. Net-net, says the report, nearly half of what the states borrow is at a very high cost.

One issue that these reports need to deal with in the future is the political element. At a recent UN conference, a western economist-cum-bureaucrat said political risk in India was high because, as it turned out, he was unable to tell the difference between democracy and political risk. Future reports would do well to address this confusion, which prevails in many Indian minds as well.

*Special Report State Government Finances