State finances: On the mend?

The combined size of the Budgets presented by 29 states of India is now at least 37 per cent more than the Union Budget. Compared to the Union Budget size of ~24.42 trillion for 2018-19, the states’ budget size for the current year is estimated at about ~33.59 trillion.

Just seven years ago, in 2011-12, the Union Budget size was bigger than the state Budgets. But since then, the combined size of the state Budgets has been growing rapidly. Last year it was 36 per cent more than the Union Budget and in

2014-15, the first year of the Modi government at the Centre, the state Budgets size was 16 per cent more than that of the Union Budget.

In spite of the massive 161 per cent rise in state Budgets in the last seven years, compared to a much lower rise of 87 per cent for the Union Budget in the same period, there is an acute shortage of analysis of how the states are raising their resources and spending them. This is largely due to a lack of a standardised format of Budget presentation by the states and unavailability of comparable numbers from all of them.

For the past many years, the Reserve Bank of India (RBI) has been coming out with an annual study of state Budgets. But until last year, this used to come out with a lag of almost one year. For instance, the study published in May 2017 covered up to only the Budget estimates for 2016-17, even though the year was long over.

That gap has now been plugged and the RBI has put out data that cover the state Budgets for 2018-19, along with the revised Budget estimates for 2017-18. This is a major initiative and will go a long way in providing upto-date state Budget data in a format that allows comparison among states and over a period of time. Thus, there is now no need to wait for a year or two before getting an authentic estimate of the total government deficit for the Centre and the states for last year or what the total government deficit is projected for the current year.

For the record, the combined fiscal deficit of states and the Centre rose to a level of 6.7 per cent of gross domestic product (GDP) in 2014-15 and widened further to 7 per cent each in the following two years. This happened as the state budgets’ deficit rose in this period even as the Union government’s deficit declined.

That trend is changing. Fiscal deficit of both the states and the Centre is now set to decline. Already, the total government deficit fell to 6.6 per cent in 2017-18 and is projected to decline further to 5.9 per cent in 2018-19. There is no room for complacency, but the availability of such data points will allow a more informed debate and greater scrutiny of public finance.

There are many such budgetary trends that can be deciphered from the latest RBI study. But three key takeaways from state Budgets of last year and the current year are worth recounting here.

One, the overall gross fiscal deficit of states declined to 3.1 per cent of GDP in 201718, even though it stayed above the prudent level of 3 per cent for the third successive year (3.5 per cent in 2016-17 and 3.1 per cent in 2015-16). What should cause concern is that the Special Category states (the eight north-eastern states, Jammu & Kashmir, Himachal Pradesh and Uttarakhand) had run up a fiscal deficit of 6.6 per cent, which was largely responsible for the states staying above the prudent level of 3 per cent. The non-Special Category states, on the other hand, were relatively safe at 2.9 per cent.

Remarkably, however, the state Budgets for 2018-19 show a healthy recovery on the fiscal deficit front. These 29 states have projected a combined fiscal deficit of 2.6 per cent of GDP. Even the Special Category states have projected a recovery at only 3.4 per cent and the non-Special Category states have budgeted for a deficit of 2.6 per cent.

But how credible are these numbers? And that is the second takeaway from the RBI study, which shows there is a disconcerting gap between the projections on deficits and the actual performance. In particular, the period between 2014-15 and 2017-18 has seen an underestimation of fiscal deficits, leading to slippages.

The study highlights two other areas of concern. The budgeted revenue deficit has overshot the estimates even in earlier periods and the slippages from 2016-17 also reveal a deterioration in the quality of expenditure, with the ratio of revenue spend to capital expenditure rising for all states. There is an obvious need for the states to follow prudent public financial management practices.

The third and final takeaway from the RBI study pertains to the roll out of the goods and services tax (GST) and its long-term benefits for state revenues. The states’ own tax revenue in 2017-18 was to have risen to 6.6 per cent of GDP, compared to 6 per cent in 2016-17. However, the revised estimates show the revenue at 6.3 per cent of GDP.

The RBI study notes that this could be because of the pending accounting issues on refunds related to the GST. Moreover, not every state has provided all its GST data making it difficult to capture the full impact of the new tax regime on state revenues. The true picture on the GST’s impact on state finances will be available in 2018-19 and the verdict on the credibility of the reduced fiscal deficit numbers will have to wait till then.

Two factors could be a spoilsport for the potential benefits from the GST: the phased implementation of various pay commission awards in the current year and the agricultural debt waiver schemes being rolled out in different states.

Already, the share of expenditure on wages and salaries in the states’ revenue spend is ranging between 19.1 per cent and 54.6 per cent, against the upper limit of 35 per cent fixed by the 13th Finance Commission. And the impact of farm debt waivers in states rose to 0.27 per cent of GDP last year and is estimated at 0.2 per cent of GDP in the current year. If the GST benefits have to be sustained and the target of a lower fiscal deficit has to be achieved, the states must keep a watch on both their wage bills and farm debt waiver expenditure.