Left alone, states' funds thrive: Fitch

BANKER'S CONFERENCE 2006

International credit rating agency Fitch Ratings has said finances of Indian state governments are on the mend, especially since the reforms initiated following the Twelfth Finance Commission report.

Fitch is optimistic about the future of state government finances as the implementation of the Finance Commission report will subject states to greater market discipline and reward them for fiscal consolidation and fiscal correction, it said.

Fitch commended the Commission's suggestion that the Central government confine itself to extending plan grants to states, and leave it to states to decide how much they wish to borrow and from whom.

"This disintermediation of the Centre in the borrowing process will lessen the states' fiscal burden, compel them to open themselves to greater market scrutiny, and foster the development of a market for state paper," Fitch said in a report on Indian State Government Finances.

Prior to the implementation of the Finance Commission report, most states were provided plan funds at a fixed grant-loan ratio of 30:70, which meant that for every Rs 30 a state received as grant, it also received Rs 70 in loans, by default, from the Centre.

"Since the Centre lent these funds to the states at interest rates that were usually higher than the open market rate (at least for the better-managed states), the states were forced to bear the burden of the planning process," Fitch said.

The rating agency said such structurally mandated borrowing helped state indebtedness and culminated in a state-level fiscal crisis in 1999-2000 (April-March).

It also said the plan system, which was designed to accelerate growth in a public sector-dominated economy and now sits uncomfortably with the requirements of an increasingly market-oriented economy, should ideally be done away with altogether.