RBI cautions states with over 4% fiscal deficit, urges tax reforms

Says returning to OPS would put substantial burden on finances

The Reserve Bank of India (RBI) has raised concerns about the fiscal management of some states, saying they have budgeted for deficits exceeding 4 per cent of Gross State Domestic Product (GSDP) in 2023-24 (FY24). The national average is 3.1 per cent.

These states have debt levels surpassing 35 per cent of GSDP compared to the national average of 27.6 per cent, said the RBI in a report on Monday.

Any additional allocation for non-merit goods and services, subsidies, transfers, and guarantees could jeopardise the fragile fiscal situation of these states, potentially disrupting the overall fiscal consolidation achieved over the past two years.

 

The report is released once a year.

Highlighting the medium-term challenges to fiscal sustainability, the report underscored the risks associated with some states contemplating a return to the old pension scheme (OPS). The RBI warned that such a shift could impose a substantial burden on state finances, limiting their capacity to undertake growth-enhancing capital expenditures.

The central bank’s estimates suggest that if all states revert to OPS from the National Pension System (NPS), the cumulative fiscal burden could balloon to 4.5 times that of NPS with an additional burden of 0.9 per cent of GDP annually by 2060. The reversal could impact the pension obligations of older OPS retirees, extending until the 2060s, marking a significant setback that undermines past reforms and compromises the interests of future generations.

The report suggested a strategic approach to bolster fiscal capacity, emphasising uninterrupted and efficient delivery of social, economic, and general services. The implementation of the goods and services tax (GST) has helped in formalising the economy and expanded the tax base without imposing undue burdens. The RBI report recommended that enhancing tax administration, incorporating data analytics to curb evasion, and reinforcing the institutional strength of state revenue departments will likely augment fiscal capacity.

In order to incentivise states in boosting tax revenue collections, the report suggested considering financial incentives. Additionally, for sustained fiscal consolidation, the RBI recommends a potential examination of reinstating fiscal efficiency parameters.

The report highlighted the significance of mining as a crucial source of non-tax revenue for mineral-rich states and suggested a robust mechanism to prevent, detect, and curb illegal mining activities. Modern technologies, such as Geographic Information Systems (GIS) and Drone Surveys, are encouraged for effective enforcement, the report said.

It further said Finance Commissions could recommend an increased share of conditional transfers based on reforms, the quality of expenditure, and fiscal sustainability to encourage healthy competition among states and improve economic performance.

Given India’s diverse climate vulnerabilities, the report suggested the need for states to focus on climate action. It urged collaboration with the Central government, adoption of energy-efficient practices, and customisation of climate actions to local needs. States’ coordination with the Centre and other stakeholders was deemed crucial for addressing climate-related challenges and fostering sustainable development.

The integration of climate finance into the broader fiscal planning processes of states was highlighted. The report suggests introducing performance-based incentives for states making significant progress toward climate goals, such as additional grants for reducing emissions or increasing renewable energy generation.

The report said that in the medium term, states should enhance transparency and public awareness of their fiscal initiatives by improving information dissemination platforms. They should establish state-specific platforms similar to a press information bureau for releasing policy-related notifications. Additionally, the report suggested the disclosure and dissemination of sensitive information about guarantees, off-budget borrowings, total resource transfers to lower tiers, and states’ expenditures on research and development to increase transparency and enhance credibility and confidence in state finances.