Flatter to deceive

After a few good years, states slip on the fisc

The one unequivocal success of the Narendra Modi-led government is an improvement in the Centre’s fiscal state. But these gains have largely been lost because of a reverse trend at the state level. After contracting for a few years, state-level fiscal deficits have done a u-turn: They have ballooned even as expenditure has soared. An HSBC Research analysis of the Budgets of 16 states that account for almost 85 per cent of the economy shows that, in aggregate, they sustained a higher fiscal deficit in 2016-17 at 2.8 per cent of GDP (revised estimates) compared to the budgeted estimate of 2.6 per cent. This is 80 basis points higher than the 2 per deficit level that the states maintained on average during their most disciplined years — 2010-11 to 2013-14. The poorer fiscal performance is surprising when one takes into account the fact that the central government’s transfers to the states have been rising since the recommendations of the Fourteenth Finance Commission came into effect. The Centre has had more revenue to share, thanks to unexpectedly higher tax collections, but it also made higher non-tax transfers to the states over the last year. Moreover, it is not just the amount but also the composition of the Centre’s transfers that has changed — the proportion of “untied” funds, which the states can spend as they like, has risen vis-à-vis “tied” funds. 

So what caused the slippage? The analysis reveals that it wasn’t a fall in revenue collections, even though the states did falter on their own tax revenues — stamp duties and states’ VAT on oil products were weaker — yet these per se could be made up by higher central transfers. The real culprit has been higher expenditure. Worse still, the increase in expenditure was solely due to higher current expenditure even as capital expenditure fell. This quality of expenditure (proxied by the capital-to-current expenditure ratio) is the most worrying bit. The budgeted fiscal deficit for 2017-18 is again 2.6 per cent of GDP but this will come under pressure from at least three key developments. The increase in the wage bill due to the Seventh Pay Commission could cost about 0.20 per cent of GDP to the states over and above what they have provisioned for. The Ujjwal Discom Assurance Yojana is being financed by bonds and the interest payment on these could cost an additional 0.05 per cent of GDP to the states. Lastly, seven states will go into election mode in the current financial year and this will further bump up expenditure.

But, even at 2.8 per cent, it can be argued that the states’ fiscal deficit is within the 3 per cent limit mandated by the Fiscal Responsibility and Budget Management (FRBM) Act. It can also be argued that for the time the Centre’s improved fiscal performance will keep the overall deficit within the limit. Yet, as the gap between yields on state and central government bonds widens — it is 80 basis points as against a long-term average of 50 basis points — it will push up the interest bill for the states, ensuring that the quality of their spending remains weak even if they contain overall borrowing. The states would do well to reverse this trend.