The Fiscal health of States


    The Fiscal health of States

    Syllabus: GS2/ Polity and Governance 

    In Context

    • It has been observed that States’ fiscal health improved after Covid-19 pandemic stress.

    Fiscal position of States

    • Size of the State’s revenue & expenditure
      • In India, the States mobilise altogether more than a third of total revenue, spend 60% of combined government expenditure, and have a share in government borrowing that is around 40%. 
      • Given the size of the fiscal operation of States, an up-to-date understanding of their finances is critical in order to draw evidence-based inferences on the fiscal situation of the country 
    • Receding fiscal deficit:
      • It is becoming evident that the increase in general government deficit and debt that occurred during the COVID-19 pandemic has begun to recede. 
      • There have been significant post-pandemic fiscal corrections at the Union and State levels. 
        • At the Union level, the fiscal deficit declined from 9.1% of GDP in 2020-21 to 5.9% in 2023-24 (BE). 
        • All State fiscal deficit was 4.1% of GDP in 2020-21. It declined to 3.24% of GDP in 2022-23 (RE). 
        • For the major States, for the year 2023-24 (BE), it is expected to be 2.9% of GDP.
    • Data collection:
      • The analysis here is based on the data collated from the individual Budgets of 17 major States
        • These States are responsible for more than 90% of the combined spending of all States. 
      • Thus, fiscal issues emerging out of their Budgets are representative of the State finances in India. 
    • Fiscal consolidation
      • The analysis shows that these States together have managed to contain their fiscal deficits. This fiscal consolidation is significant in many ways. 
        • States in aggregate managed to be fiscally prudent despite a significant contraction in revenues even during the peak of COVID-19. 
        • Emergency provision for health spending and livelihood during the COVID-19 pandemic was not easy and required Union-State fiscal coordination. 
        • States were able to reprioritise expenditure and quickly contain the fiscal deficit. 
        • The reduction in fiscal deficit is a combination of expenditure-side adjustments, improved Goods and Services Tax (GST) collection and higher tax devolution due to buoyant central revenues. 
        • Non-GST revenues are also showing signs of recovery after the pandemic in most States.

    N K Singh Committee’s Recommendations on Fiscal Deficit

    • The N.K. Singh panel to review India’s fiscal discipline rules has recommended a debt-to-GDP ratio of 38.7% for the central government, 20% for the state governments together and a fiscal deficit of 2.5% of GDP (gross domestic product), both by financial year 2022-23.
      • The debt-to-GDP ratio is the ratio of a country’s debt to its gross domestic product (GDP).
        • A high debt-to-GDP ratio is undesirable for a country, as a higher ratio indicates a higher risk of default. 


    • Absence of aggregating fiscal data:
      • Due to the absence of aggregation of individual State Budget data, a consolidated view of general government finances is not readily available. 
      • Every year, this data becomes available only after the publication of the Reserve Bank of India’s (RBI) Annual Study on State Finances. 
      • Aggregating fiscal data from individual State Budgets is rigorous and time consuming
        • Hence, the timeline of this publication by the RBI is during the second half of the fiscal year.
    • Containing the revenue deficit of States:
      • The reduction in fiscal deficit has not been accompanied by a corresponding reduction in revenue deficit
        • As of 2023-24 (BE), out of 17 major States, 13 States have deficit in the revenue account. 
      • Out of 13 States, fiscal deficits in seven States are primarily driven by revenue deficits; the States being Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal. They also have large debt to GSDP ratios.
    • Long-run implications of fiscal stress:
      • An assessment of successive Finance Commissions since the Twelfth Finance Commission identified three States, i.e., Kerala, Punjab and West Bengal, as fiscally stressed States.
      • Increasing revenue deficit driving the fiscal imbalance has long-run fiscal implications and there is a need to correct this imbalance in the revenue account.

    Suggestions & way ahead

    • On the question of revenue deficit, a long-run view is also necessary
    • The re-emergence of revenue deficit in recent years should take the focus back on the management of revenue deficit by creating an incentive compatible framework
      • The following measures can be considered.
        • Interest-free loans to the States by the Union Government, if continued, may be linked to a reduction in revenue deficit
          • This will help eliminate the possibility of a substitution of States’ own capital spending and also prevent the diversion of borrowed resources to finance revenue expenditure. 
        • A defined time path for revenue deficit reduction with a credible fiscal adjustment plan would help restore fiscal balance and improve quality of expenditure.
        • A forward-looking performance incentive grants could also be considered for a reduction of revenue deficit. 
          • In this context, different approaches provided by earlier Finance Commissions can be considered to decide the framework of the incentive structure.
    • A comprehensive revenue deficit reduction framework is essential to improve the fiscal health of States.
    • In conclusion, we need to get the focus back on the management of revenue deficit. For this, a macro view is essential.

    Mains Practise Question 

    [Q] How far do you agree with the view that the fiscal stability of State finances is critical to ensure higher State-specific growth ? What measures can be undertaken for the management of the revenue deficit of states in India?