NITI Aayog's fiscal health index needs clarity and better data use

Despite fact that Constitution assigns states predominant role in provision of social services and co-equal responsibility in economic services, their fiscal performance has not received much focus

By and large, in India, fiscal performances are judged from the viewpoint of tax policy, on the one hand, and the deficits and debt of the Union government, on the other. Of course, the focus on deficits and debt is important for macroeconomic stability and growth, and analysis of tax policy is important because it affects disposable incomes, aggregate demand, and relative prices. Despite the fact that the Constitution assigns the states a predominant role in the provision of social services and co-equal responsibility in economic services, their fiscal performance has not received much focus. In this regard, the recent report of the NITI Aayog on the fiscal health index (FHI) is notable. However, it is important to recognise that the index from the viewpoint of macroeconomic stability is not the same as adequacy and efficiency in public-service provision. Besides, there are a number of conceptual and measurement issues and considerable refinement needs to be done before this is used for any policy purposes. 

Based on the data sourced from the Comptroller and Auditor General (CAG), the report attempts to measure the FHI of 18 major states by combining five sub-indices with equal weights assigned. The five sub-indices are presumed to represent the quality of expenditure, revenue mobilisation, fiscal prudence, the debt index, and debt sustainability. The quality of expenditure is measured by (i) the share of development expenditure in the total and (ii) the share of capital expenditure in gross state domestic product (GSDP). Revenue mobilisation is measured by (i) the share of the states’ own revenue to GSDP and (ii) the share of states’ own revenue in total expenditure. Fiscal prudence is measured as (i) the ratio of the fiscal deficit to GSDP and (ii) the revenue deficit to GSDP. The debt index is calculated by taking (i) the ratio of interest payments to revenue receipts and (ii) the ratio of outstanding liabilities of the state to GSDP. And finally debt sustainability is measured by the difference between the growth rate of nominal GSDP and the growth rate of interest payments. The estimates are for 2022-23 and the trend analysis using the methodology has been presented for the period 2014-22 and that is also given in the appendix of the report. Notably, there is no indicator to represent the volume of services provided. 

The measurement of the states’ fiscal health is important for their fiscal-policy calibration. However, it is necessary to ensure that there is conceptual clarity on what is sought to be measured. It is also necessary to use accurate and comparable data to ensure that the index measures what it is intended for. This is particularly so since the report has been put out by the NITI Aayog, a premier government think tank. At a conceptual level, any summary measure cannot provide a holistic picture. A fiscal-health indicator seen from the viewpoint of macroeconomic stabilisation or from the perspective of adequacy and quality of public services provided. According to the first-generation theories of fiscal federalism, macroeconomic stabilisation is predominantly (not exclusively) a central function and sub-national governments’ focus is in providing the desired level of public services. The three sub-indexes taken for measuring the FHI pertain to deficits and debt, which is relevant from the stabilisation perspective. Even here it is unclear how the difference in the growth rate of GSDP and interest rates measures debt sustainability. The debt-GSDP ratio declines when the growth rate of nominal GSDP exceeds the effective interest rate and not its growth. In any case, the sub-indices representing the deficit and debt have little relevance to the states’ objective of providing the required levels of public services. Thus, Odisha, Chhattisgarh, and Jharkhand, which rank high in the present analysis, are unable to have adequate teachers in educational institutions and health workers and medicines and equipment in hospitals. The first two sub-indices — the quality of expenditures and revenue mobilisation — do not measure the volume of public services provided. Generally developmental outlay is measured by aggregating expenditures on social and economic services. These include subsidies and transfers, including power and transport subsidies and those given for social security. Further, the basic requirement for development is law and order, ensuring property rights and enforcing contracts, which, however, do not come under development spending. Similarly, the ratio of a state’s own revenue to its revenue expenditure merely shows the fiscal dependence due to fiscal disabilities. Even when a state with a low revenue-raising capacity has the best tax effort, it has to depend on the Union government for the basic requirements. As mentioned above, the states’ principal mandate is to provide the assigned volume and quality of public services, which is approximated by taking per capita expenditures.

 

Equally important is the need to clean up the data to avoid inaccuracies and make it comparable across states. To begin with, the data on GSDP is estimated by the respective states’ economics and statistical bureaus and is not strictly comparable. Comparable estimates are provided by the Ministry of Statistics and Programme Implementation for specified years only to the Finance Commissions, and the NITI Aayog would do well to request the ministry to provide comparable estimates annually. The data presented in Budgets is designed for accountability and audit, and for economic analysis, it is necessary to adjust it to reflect the revenue and expenditure position from economic and functional perspective. Specifically, the transfers to various reserve funds kept in public accounts are considered “expenditure”, and expenditures met from such funds are deducted. It is necessary to make reverse adjustments to reflect the correct picture. Second, a number of states run public enterprises in transport and electric utilities departmentally and their Budgets overstate both revenue and expenditures by taking their gross turnovers as revenues and costs as expenditures. The Punjab Roadways is a clear example of this. It is important to deduct the expenses from revenues and show the net receipts in such cases. The same is the case with lotteries run by state governments. Finally, a major source of distortion is off-Budget liabilities, which, in the main, are in electricity distribution. The Kerala Infrastructure Investment Fund Board is another example of borrowing outside the Budget and the proceeds from the Motor Vehicles Tax and petroleum cess are escrowed to finance its debt servicing. The CAG has objected to this and the matter has to be decided in the High Court of Kerala.  

Thus, while the initiative of the NITI Aayog is noteworthy, it requires considerable conceptual clarity and data adjustment before being used for analytical and policy purposes. 

The author is chairman, Karnataka Regional Imbalances Redressal Committee.  The views are personal