New Delhi
Call it competitive federalism in a new avatar. Indian states are vying for top slots in the pecking order of debt accumulation as the outstanding debt burdens of these federal entities stay on an upward trajectory since the Covid-19 pandemic hit, with Madhya Pradesh topping the rise with a 79 per cent jump. This is as per the Reserve Bank of India’s report on state finances, ‘A Study of Budgets of which highlights Tamil Nadu, Uttar Pradesh, Maharashtra, West Bengal, and Rajasthan as contributing significantly to taking the total debt accumulated by India’s state governments and Union Territories (UTs) to a record high during the financial year 2022–23 by registering a huge increase in their liabilities on an annual basis. While trends in state finances usually make the local headlines during elections to an assembly for war over merit or demerits of government spending, the matter has gone beyond election rhetoric, with growing national recognition and uneasiness among policymakers that state debt has spiked considerably and is uncomfortably above the tolerance band.
Underscoring the concern are numbers from the government during the Budget session of Parliament in 2023, which peg a 43 per cent rise in the outstanding liabilities of 28 states in the three years from March 2020 to March 2023. All in all, the outstanding liabilities of all these states are expected to reach Rs 75 lakh crore by the end of FY23, up from Rs 52 lakh crore in March 2020, when the COVID-19 pandemic forced a nationwide lockdown in India. The RBI report flags the spike in debt burdens as a “cause for concern as refinancing this debt over the coming years will keep interest rates in the economy high”.
In this context, a study on ‘State Budgets in India: Time Trend Analysis from 1990 to 2020’ by Shamika Ravi (Member, Economic Advisory Council-PM) and Mudit Kapoor of the Indian Statistical Institute offers important lessons for two stakeholders: the next Finance Commission on immediate and urgent attention to be paid to state pension programmes and the structure and servicing of public debt, as well as for NITI Aayog as a pivotal platform for states to share best practises in financial management, administrative efficiency, and structuring of capital outlays. The report comes timely amidst the Central Bank’s ongoing battle against inflation, which has seen a sharp hike in interest rates from the record lows of the pandemic era. Moreover, forthcoming assembly polls and the national elections next year, which have prompted a slew of pre-election sops and freebies, including the move by some administrations to move back to the so-called old pension regime guaranteeing defined returns for retiring government employees, have put the spotlight back on states’ fiscal discipline.
The data for the state of finances of all the states and UTs offered by Shamika Ravi and Mudit Kapoor’s report reflects that high-growth states have significantly increased their capacity to generate their own tax revenues, while low-growth states are lagging. Thus, more than 50 percent of the revenue of high-growth states such as Gujarat, Tamil Nadu, Haryana, Maharashtra, and Karnataka comes from their tax revenue. On the other hand, West Bengal, Assam, Uttar Pradesh, Chhattisgarh, and Jharkhand are low-growth states that have greater reliance on shares in central taxes or grants from the Centre. Their own tax revenue is well below 40 percent. In the case of Punjab, the share of the state’s own tax revenue was more or less greater than 50 percent till 2008 and rose sharply to 60 percent in 2010. Thereafter, there has been a dramatic decline in this share. In recent years, the percentage of grants from the Centre has risen sharply for Punjab, indicating perhaps the changing economic environment in the states.
In another insight on the composition of expenditure in states, the Ravi and Kapoor study shows that in large ones such as Kerala, Punjab, Maharashtra, Karnataka, and Gujarat, typically, expenditure per capita exceeds the all-India level. It is significantly below the all-India level in West Bengal, Bihar, and a few others. Expenditure falls into two categories.
Development expenditure is primarily on social services and economic services, which relate to rural and urban development and infrastructure. The share of development expenditure remains more than 50 per cent for all large states, except for Punjab and Kerala, where it was less than 50 per cent. In West Bengal and Uttar Pradesh, the share of development expenditure has declined from 1990 to 2020. On a closer look at the two categories of social and economic services, the Ravi and Kapoor study observes that the share of social services is between 50 per cent and 60 per cent of the total development expenditure. It remains relatively stable over time and across states, except for West Bengal, Delhi, Uttarakhand, and Tripura, where it was over 70 per cent.
Interest payments account for the largest share of non-development expenditures in Indian states. For combined data for all states and UTs, the share of interest payments and debt servicing rose from 1990–91 to the mid-2000s and then declined by 2020–21. As per the report, interest payments and debt servicing as a percentage rose from 20 percent in 1990–91 to more than 40 percent in 2004–05 and declined to around 20 per cent in 2020–21. Compared to their development spending, Kerala, West Bengal, and Punjab have alarming levels of debt burden. In the states of Kerala and Punjab, there seems to be a reversal in trend since 2011–12, where the share of interest payments and debt servicing has risen. For Kerala, it has risen from approximately 25 per cent to more than 30 per cent, but in Punjab, it has increased from 30 per cent to more than 40 per cent. In both of these states, the report observes a decline in development expenditure. It is also worth noting that in West Bengal, the share of interest payments and debt servicing to development expenditure has been higher than the all-India level. In terms of the debt-to-gross state domestic product ratio, a measure of how much the liabilities are as a proportion of the size of the state’s economy, Punjab comes out as the worst of the lot, with the ratio at a whopping 48 per cent as of March 2023.
Delving into another aspect of state finance, which is capital outlay for development purposes, which is a significant determinant of long-term economic growth and improving productivity of state economies, Ravi and Kapoor observe that for all the states and UTs combined, the per-capita total capital outlay for development (in constant 2011–12 prices) increased from 475 in 1990–91 to 511 in 1999–00. It grew from 611 in 2000-01 to 1553 in 2008-09, declining to 1332 in 2010-11 and then rising to 1926 in 2020-21. Punjab and West Bengal, which lag behind the national average in real per-capita growth, have invested the least in capital outlay for development. Perhaps this reflects the significant capital disbursement towards the discharging of internal debt. This leaves practically no room for capital outlay for development, which could be why these states are lagging in growth.
The report by Shamika Ravi and Mudit Kapoor emphasises administrative efficiency in light of India’s ambition to become a developed country by 2047 and calls for creating a knowledge-sharing platform where states with high administrative efficiency can disseminate the best practises to lagging states. A key concern flagged by the report and perhaps relevant to states like West Bengal, which has been witnessing large-scale lawlessness and disorder, is that conflicts are costly. Conflicts necessitate higher spending on security, such as police, and simultaneously lower the level of net state domestic product. Hence, the most significant dividend from conflict resolution is greater resources for development. “States such as Punjab, which have successfully resolved past conflicts, continue to incur high levels of police expenditure, perhaps reflecting the persistence in government expenditure,” the report says.
As for the road ahead, the RBI cautions in its’study of Budgets of 2022–23’ that states will continue to be fiscally constrained even if they lower their borrowings in the coming years or, in fact, borrow less than projected amounts from the debt market. From April to November 2022, the combined borrowings of the 27 major states have just reached 33.5 per cent of their total budgeted borrowings for the year. The data from the last three years shows that states have unutilized borrowing limits. While there is also comfort in the fact that states’ debt is budgeted to ease to 29.5 per cent of GDP in 2022–23 as opposed to 31.1 per cent in 2020–21, it is still higher than the 20 per cent recommended by the Fiscal Responsibility and Budget Management Act, 2003, Review Committee, warranting prioritisation of debt consolidation. Increased allocations for sectors like health, education, infrastructure, and green energy transition can help expand productive capacities if states mainstream capital planning rather than treating them as residuals and first stops for cutbacks in order to meet budgetary targets, suggests the RBI study. States also need to encourage and facilitate higher inter-state trade and businesses to realise the full benefit of spillover effects of state capex across the country.