The vital third tier

Local governments must be strengthened

The Reserve Bank of India (RBI) has released its annual study of state finances, which is a vital resource for observers of the Indian political economy, given the difficulties faced otherwise in aggregating and analysing state government budgets. The headline point, with important implications for the general government budget, is that the states’ gross fiscal deficit breached the 3 per cent of gross domestic product (GDP) mark required by fiscal responsibility legislation. The report pointed out that the combined revenue deficit of the state governments in particular rose from 0.1 per cent of GDP in 2018-19 to 2 per cent of GDP in 2020-21 under the stress of the pandemic. This was in spite of a sharp squeeze in expenditure during the pandemic, especially on services, development, and welfare. Driven by revenue receipts being less than budgeted by as much as 2.7 per cent of GDP, the consolidated gross fiscal deficit of the state governments rose to a record high in 2020-21. Concerns from state governments about their fiscal position and disagreements about goods and services tax compensation need to be viewed in the light of this severe fiscal stress on state capitals. The RBI is nevertheless hopeful that robust tax collection by the Union in the ongoing year and a return to normalcy following widespread vaccination will allow states to “map out a credible glide path for fiscal consolidation over the medium term”.

The special focus of this iteration of the RBI report was, however, on local body finances and particularly urban local bodies and municipal corporations. This focus is also motivated by the pandemic, in which local bodies turned out to be frontline responders not just in mitigating the two most severe waves of infection but also in terms of managing the vaccination roll-out. The report’s authors surveyed 141 municipal corporations and analysed the budgets of the 20 largest ones. The results are of great importance, indicating that fiscal stress on the third tier of government is as great if not greater than on the Union and the states — unsurprising, since local bodies are constrained to avoid running deficits and borrowing without explicit state government permission. They also faced a steep loss of revenue, with 98 per cent of the respondents reporting fiscal challenges in the RBI survey. Notably, revenue seemed to have been more affected by the second wave earlier this calendar year than by the first wave, with almost a quarter of municipalities reporting their revenue shrank by more than half. The RBI estimates that about a third of municipal corporations are “severely fiscally stressed”. This has major implications not just for development and welfare but even for the response to the pandemic; statistical analysis in the report demonstrates that the more fiscally stressed an urban area is, the worse it is performing in terms of the vaccination roll-out.

Help was indeed provided to the municipal corporations, with over 40 per cent of them reporting pandemic-related state government grants helped them cover the required expenditure. But even so, many of them dipped into reserves. This is not a sustainable mechanism for a post-pandemic recovery and indeed for quality urbanisation in India. Few municipal corporations tap the markets for supplementary finance; only five respondents out of more than 200 issued bonds during the pandemic. Institutional reform is vital. Transfers from the upper tiers of government should be quicker and easier to access. But equally, the municipal bond market must be a major focus for future financial sector reform.