Debt sustainability: A roadmap for India's states and local governance

Debt Sustainability of Subnational Governments in India

Author: Hari Krishna Dwivedi

Publisher: OUP 

Pages: 256

Price: Rs 1,162

  Worrying about the debt sustainability of subnational governments (SNGs or state governments in India) is an acquired taste even amongst financial analysts. In the hands of an experienced professional, like the author — a distinguished civil servant, till recently chief secretary to the government of West Bengal — this rarefied subject is unravelled for practitioners and the uninitiated via a user-friendly arrangement of the extensively researched and referenced content.

 

A 101 review of the structure and nature of public debt and its role in economic development set the stage, along with a review of debt crises in Brazil, Argentina, and Mexico (1980 to the 2000s), the Greek and Portuguese debt crises in 2010 and more recently Sri Lanka and Pakistan in 2022. Paradoxically, individuals and corporations heed the threat of bankruptcy more readily than sovereigns, mostly because it is hard to hold a rule-maker accountable for violating rules. India is an exception with a squeaky-clean record of debt servicing. 

SNGs in India are accountable to the Union government but are not uniformly as diligent in maintaining fiscal resilience and debt sustainability. The debt-to-GDP ratio of Indian state governments increased from 18 per cent in 1980 to about 33 per cent in 2002, inducing regulatory legislation. The Fiscal Responsibility and Budgetary Management Act, 2003, prescribes a fiscal deficit rule of a maximum 3 per cent of GDP and a debt-to-GDP ratio of 20 per cent for SNGs and 30 per cent for the Union government. Sadly, medium-term Budget formulation remains delinked from fiscal targets, diluting the usefulness of fiscal norms. Nor are deviations from norms penalised, possibly because fiscal rules remain inflexible to the need for pump priming in downturns and enhanced fiscal restraint during upturns. The quality of the fiscal adjustment is also inadequate, squeezing capital expendi­ture whilst privileging politically sensitive revenue expenditure — as evidenced since 2001. 

In 2020-21 only two of 18 major states, Odisha and Maharashtra, achieved the debt-to-state GDP norm of 20 per cent. Gujarat and Karnataka were close at 21 and 22 per cent respectively. Six states had debt ratios above 35 per cent of GDP while 13 states had debt ratios above 25 per cent. State-specific fiscal data becomes available with considerable lags. Nevertheless, the author suggests improving the rigour with which debt sustainability is assessed to avert debt crises by raising the red flags in advance. A Reserve Bank of India study (2022) assessed 18 large states for their fiscal response to increasing debt levels. If debt increases are followed by larger primary surpluses in succeeding years, the state is doing well on debt sustainability. All 18 states and the 10 most indebted states grouped together were sustainable, but the five most indebted states were not. Literature examining debt sustainability in India is noisy and presents no clear pattern. Some studies infer debt sustainability in the long run but not in the short term. 

This clearly is not good enough. Each state govern­ment must be independently responsible for debt sustainability otherwise it “free rides” versus more compliant state governments. The author suggests checking for continuity in relationships between variables (cointegration tests) and identifying “structural breaks” (periods of economic upheaval such as during Covid-19) in data sets to improve the explanatory value of such analysis. A next step could be a cross-sectional dependence check to further refine the analysis to suit the state-specific context, though this would enhance data requirements. 

An independent, permanent finance commission constituted on the principle of cooperative federalism could even subsume the GST Council and take real-time decisions on inter-govern­mental fiscal resilience, and safeguard against the Union gover­nm­e­nt depriving SNGs by increas­ing fully retain­able surcharge and cess rather than increasing sharable tax revenues. It could also become the node for advanced analytics and monitor real time collection of fiscal data across local governments, states, and the Union government. The record of state finance commissions is, at best, patchy. Close external oversight on state fiscal metrics could empower and modernise fiscal management in local governments, which remain hamstrung by inadequate devolution of fiscal resources and administrative powers. They receive less than 1 per cent of GDP as grants and raise their own revenues of a similar amount. 

The path to fiscal stability is not rocket science. More efficient spending, enhancing the tax base — including by taxing carbon and congestion — improved collections and monetising government land and assets are supporting pillars. But debt sustainability is a conviction beyond the adequacy of resources. Political-economy factors dominate when fiscal rules are violated. Research establishes that fiscal delinquency is most likely if governments have no expectations of retaining power.  Similarly, heading into elections incentivises governments to spend unwisely to be popular. Fortunately, India has a permanent bureaucracy, well equipped to dilute such transgressions, if only they could get their act together. 

The reviewer is consultant, economic governance & energy regulation