Incentivising states key to overall fiscal performance: Economic Survey

Centre should take the lead in sound fiscal management suggests Economic Survey

The Economic Survey 2016-17 presented in the Parliament on Tuesday has highlighted the need for fiscal prudence, both by the Centre as well as the states, in order to maintain the overall fiscal health of the economy, said the government in an official release. The Economic Survey also stated that the Centre’s Fiscal Responsibility and Budget Management (FRBM) Act was mirrored by Fiscal Responsibility Legislations (FRLs) being adopted in the states.

According to the Economic Survey, there has been an improvement in the financial position of the states over the last few years. The average revenue deficit has been eliminated, while the average fiscal deficit has been curbed to less than three per cent of GSDP. The average debt to GSDP ratio has also fallen.

However, just because fiscal progress followed the introduction of the FRLs, it doesn’t mean that the progress can be attributed entirely to FRLs, the survey added. According to the survey, the following points are important with respect to the improvement in fiscal variables:

1) The deficit reduction owes much to favourable exogenous factors (see Figure 1):

• An acceleration of nominal GDP growth (of six percentage points on average after 2005) helped boost states’ revenues by about one per cent of GSDP

• Increased transfers from the Centre of about one per cent of GSDP, both because of the 13th Finance Commission recommendations and the surge in central government revenues

• Reduced interest payments of about 0.9 per cent of GSDP on account of the debt restructuring package offered by the Centre

• Reduced need for spending by the states — estimated at about 1.2 per cent of GDP — as the Centre took on a number of major social sector expenditures under the Centrally Sponsored Schemes (CSS).

Figure 1: Decomposition of reduction in fiscal, primary and revenue deficit before and after states’ FRLs. Photo: PIB

 

2) Desisting from splurging rather than belt-tightening was probably the real contribution of the states. Despite the revenue surge, non-interest revenue expenditure rose by only 0.4 per cent of GSDP.

3) Off-budget expenditures fell, as measured by the flow of explicit guarantees and loans to public utilities falling.

4) There was a sharp drop in the magnitude of forecast errors suggesting an improvement in the process of budget formation. The shortfalls between budgeted and actual own tax revenue went from an average of 5.9 per cent of actuals (optimistic forecasts) before the FRLs to -0.6 per cent of actuals after.

5) All of these positive indicators show signs of decay in later years; fiscal deficits for example are close to the limit of three per cent on average 10 years after the FRLs (see Figure 2). 

Figure 2: Average fiscal deficit of states in years relative to adoption of FRLs (as per cent of GSDP). Photo: PIB
 

 

Economic Survey 2016-17 elaborated that as the fiscal challenges mount for the states because of the Pay Commission recommendations, and mounting payments from the UDAY bonds, there would be a need to review how fiscal performance can be kept on track. Greater reliance would need to be placed on incentivising good fiscal performance, not least because states are gradually repaying their obligations to the Centre, removing its ability to impose a hard budget constraint on them, said the Economic Survey. Above all, however, incentivising good performance by the states would require the Centre to be an exemplar of sound fiscal management itself, it added.