Framework of revenue deficit consolidation

(MainsGS3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.)

Context:

• The States in India mobilize altogether more than a third of total revenue, spend 60% of combined government expenditure, and have a share in government borrowing that is around 40%, thus up-to-date understanding of their finances is critical in order to draw evidence-based inferences on the fiscal situation of the country.

Analysis of the emerging fiscal situation:

• Fiscal situationIt is becoming evident that the increase in general government deficit and debt that occurred during the COVID-19 pandemic has begun to recede. 
• There have been significant post-pandemic fiscal corrections at the Union and State levels. 
• At the Union level, the fiscal deficit declined from 9.1% of GDP in 2020-21 to 5.9% in 2023-24 (BE). 
• All State fiscal deficit was 4.1% of GDP in 2020-21. It declined to 3.24% of GDP in 2022-23 (RE). For the major States, for the year 2023-24 (BE), it is expected to be 2.9% of GDP.

Reduction in fiscal deficit:

• The sharp reduction in fiscal deficit suggests that we cannot have an impressionistic view of the fiscal situation of the country, especially on the finances of States. 
• Due to the absence of aggregation of individual State Budget data, a consolidated view of general government finances is not readily available. 
• Every year, this data becomes available only after the publication of the Reserve Bank of India’s (RBI) Annual Study on State Finances. 
• Aggregating fiscal data from individual State Budgets is rigorous and time consuming, hence, the timeline of this publication by the RBI is during the second half of the fiscal year.

Fiscal consolidation:

• The experts analysis shows that these States together have managed to contain their fiscal deficits which is significant in many ways.
• First, States in aggregate managed to be fiscally prudent despite a significant contraction in revenues even during the peak of COVID-19. 
• Second, emergency provision for health spending and livelihood during the COVID-19 pandemic was not easy and required Union-State fiscal coordination. 
• Third, States were able to reprioritise expenditure and quickly contain the fiscal deficit. 
• Fourth, the reduction in fiscal deficit is a combination of expenditure-side adjustments, improved Goods and Services Tax (GST) collection and higher tax devolution due to buoyant central revenues. 
• Fifth, non-GST revenues are also showing signs of recovery after the pandemic in most States.

Challenges ahead:

• There are significant fiscal challenges that need correction in the short to medium time frame in which the most critical being containing the revenue deficit of States. 
• The reduction in fiscal deficit has not been accompanied by a corresponding reduction in revenue deficit. 
• As in 2023-24 (BE), out of 17 major States, 13 States have deficit in the revenue account. 
• Out of 13 States, fiscal deficits in seven States are primarily driven by revenue deficits; the States being Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal. They also have large debt to GSDP ratios.
• Thus increasing revenue deficit driving the fiscal imbalance has long-run fiscal implications and there is a need to correct this imbalance in the revenue account.

Re-emergence of revenue deficit:

• After examining data from the last 20 years, revenue deficit had almost disappeared from State Budgets before COVID-19. 
• States, in aggregate, were generating revenue surpluses almost all the years during this period. 
• However, the re-emergence of revenue deficit in recent years should take the focus back on the management of revenue deficit by creating an incentive compatible framework. 

Way forward:

• Going forward, interest-free loans to the States by the Union Government, if continued, may be linked to a reduction in revenue deficit. 
• This will help eliminate the possibility of a substitution of States’ own capital spending and also prevent the diversion of borrowed resources to finance revenue expenditure. 
• A defined time path for revenue deficit reduction with a credible fiscal adjustment plan would help restore fiscal balance and improve quality of expenditure.
• A forward-looking performance incentive grants could also be considered for a reduction of revenue deficit. 
• In this context, different approaches provided by earlier Finance Commissions can be considered to decide the framework of the incentive structure.