On February 12, state governments together held close to Rs 101,461 crore worth of 14-day treasury bills. Five years earlier, just before the Twelfth Finance Commission presented its report, that number was Rs 13,351 crore.

Investment by states in 14-day treasury bills provides the closest measure of the cash available with states, pending spending.

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Besides, the Thirteenth Finance Commission, whose recommendations would be made public on Thursday, is expected to contribute to the cause through higher devolution.

“If the Centre’s number looks better, then states benefit from that because of the transfer of taxes. Compared to this year, in 2010-11, the numbers will look better. As the economy picks up, deficit as a per cent of GDP will be lower,” said D K Joshi, principal economist at Crisil.

“The economy is looking better, so the share in central taxes will go up; the pay commission is behind us, so bunching should not occur. Hopefully, things will improve,” said the finance secretary of a north Indian state.

Pay has been revised in 13 states, though there are no estimates available on the cost these governments would incur.

During the past four years, rapid economic expansion, higher share of central taxes, conditional debt restructuring, interest rate relief and a shift to value-added tax helped improve the financial position. “One of the biggest changes seen in the last five years has been that states do not want to use the overdraft facility available to them,” says a government official who was closely associated with the last finance commission.

During 2009-10 (up to February 11, 2010), only four states – Punjab (16 days), Nagaland (13), Uttarakhand and West Bengal (8 days each) -- availed of the overdraft facility. In 2004-05, there were 13 states that used the facility, with Kerala using it for the longest period, of 161 days.

The deficit numbers for state governments also indicate the story of improvement in state finances over the past five years (see graphic), though the economic slowdown and the pay commissions spoilt the overall picture for 2008-09 and 2009-10.

During the current financial year, based on budget estimates, states would report a revenue deficit of 0.5 per cent of the gross domestic product (GDP). In contrast, they had a surplus for three consecutive years. The gross fiscal deficit, too, is budgeted to rise to 3.2 per cent of GDP in 2009-10, compared with 2.6 per cent in the revised estimates for last year. States resorted to large borrowings, since the Centre, as part of the stimulus package, agreed to relax the ceiling on fiscal deficit to 4 per cent from 3.5 per cent.

Despite all this, a report on state finances released by the Reserve Bank of India yesterday said that over the past five years, there has been a compression in consolidated expenditure due to rationalisation of revenue expenditure, led by lower interest payments. As a result, the revenue expenditure to GDP ratio declined from an average level of 13.3 per cent during 2000-05 to 12.4 per cent during 2005-10.
 

The Twelfth Finance Commission that allowed states to claim a debt waiver if they enacted a fiscal responsibility laws helped in managing the fiscal consolidation. So, it is not surprising that all states – barring West Bengal and Sikkim – put in place fiscal responsibility laws. Also, 18 states agreed to limit their pension liability by shifting to the New Pension Scheme, while an equal number have agreed to cap the guarantees they provide.

Had it not been for the economic downturn, states would have fared better than what was demanded of them. Despite the slowdown, during the current financial year, Kerala, Bihar, Karnataka, Chhattisgarh, Gujarat and Tamil Nadu managed to limit their fiscal deficit within three per cent of their gross state domestic product.

Similarly, with the fiscal responsibility law limiting their annual borrowing requirements, the debt-GDP ratio fell from a peak level of 32.8 per cent at the end of March 2004 to 26.2 per cent in 2008-09 (revised estimates). This was much lower than the Twelfth Finance Commission’s target of 30.8 per cent, to be reached by the end of March 2010.

Expenditure rationalisation apart, what helped states was higher own revenue collections, which rose to 7.3 per cent of GDP in the budget estimates for the current financial year, compared with 7 per cent during 2000-2005. The effort was led by taxes, though the recovery rate from the power sector improved during the past five years. Besides, there was an increase in central transfers from 4.2 per cent of GDP in 2000-2005 to 5.7 per cent in 2009-10.

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