Concerns about the central government’s striking reversals on fiscal consolidation have been repeatedly expressed during the past year. While the finance ministry has been maintaining the façade of discipline by pushing items like the oil and fertiliser bonds off the Budget, the stark fact is that its total borrowing requirements, including these bonds, will far exceed the Budget estimate. The sharp decline in oil and, consequently, fertiliser prices will, of course, provide enormous relief. However, at the end of the year, the Centre’s fiscal report card will certainly not warrant a good grade. However, while much attention has been paid to central government finances, the significant improvement in state finances that has been taking place all this while has not got the attention it deserves. The Macroeconomic Review published by the Reserve Bank of India as a prelude to its monetary policy announcement last week, provides a clear picture of developments on this front.
In the aggregate, state finances have reached a situation of surplus on the revenue account. In other words, they are able to collect more funds than they need to keep the government running. The overall surplus was 0.48 per cent of GDP during 2007-08 and is slightly higher at 0.54 per cent in the 2008-09 budgets. The aggregate gross fiscal deficit, which effectively reflects the amount that the states are investing, was 2.3 per cent of GDP in 2007-08 and is budgeted at 2.1 per cent in 2008-09. While it is too early to make an assessment of the actual situation this year, the evidence of borrowing and overdrafts by state governments that is presented in the Review suggests that things have not gone off track. This relatively rapid improvement in state finances, which at the aggregate level have met if not exceeded the fiscal responsibility targets a couple of years ahead of schedule, is the result of a number of complementary factors. Overall revenue buoyancy led to larger transfers from the Centre. Many states have successfully introduced the VAT and have seen significant revenue growth on their own. And, there are signs that governments have become more diligent about collecting taxes and other charges. This improvement now creates the room for states to make critical infrastructure investments. One can only hope that they get their act together on this front as quickly and effectively as they did on the revenue side.
As positive as these developments are, however, a number of recent developments may have an adverse impact on state finances. The slowdown in growth will reduce the rate of growth in central revenues and, therefore, of transfers to states. It will also have some impact on VAT collections, though this may be offset by continuing efficiency improvements. The slowdown in the real estate sector will also mean less revenue. On the expenditure side, salary hikes will put pressure on finances; in some states, these could reverse the improvement of recent years. However, these threats notwithstanding, it is commendable that states as a group have been able to achieve the fiscal responsibility targets with far greater ease than the Centre. Of course, this is not the end of the road. There is still a long way to go with respect to the delivery of public services by state governments. Along with stepping up public investment, this must be their next area of focus.
