Assessing State level finance model in India

During a recent interview, the Prime Minister underscored the need for fiscal discipline for state governments, which essentially refers to governments spending within their means.

How should state government finances be judged?

They analysed data for 27 states on four different counts:

• Fiscal Deficit (which refers to the amount of money a state government has to borrow to meet its annual expenditure) expressed as a percentage of overall size of the state’s economy (the gross state domestic product or GSDP).
  • It is related to how state government has to borrow in the current financial year to meet the gap between its expenditures and revenues.
  • Fiscal deficit should not exceed more than 3% of a state’s GDP.
• Debt (that is, the accumulated borrowings by the government over the years) expressed as a percentage of GSDP.
  • Debt levels should not go beyond 20% of a state’s GDP.
• Outstanding guarantees that a state government provides; again expressed as a percentage of the GSDP.
  • They refer to debts that are on the books of state government-run entities but are effectively backed by the state government.
• Percentage of the total revenue income that a state government has to spend towards paying off the interest component of its debt.

Status of India’s states in finances:

• On debt levels, only three states i.e. Odisha, Gujarat and Maharashtra — in India manage to meet the prudential norm.
• On the fiscal deficit front, three states — Punjab, Manipur and Arunachal — have fiscal deficit of 5% and above.
• There are four states — Karnataka, Telangana, Assam and Chhattisgarh which are at a debt level of less than 25%.
• Tamil Nadu, Haryana, Jharkhand, Uttarakhand and Madhya Pradesh — have debt ratios between 25%-30%.

How state government manages their finances?

• Revenue Generation:
  • Taxation: State governments have the authority to levy and collect various taxes, including state-level income tax, sales tax (GST), excise duties, and stamp duties. These taxes contribute significantly to their revenue.
  • Non-Tax Revenue: States also generate income through sources such as fees, fines, penalties, and revenue from state-owned enterprises.
  • Grants: The central government provides grants to states as part of its revenue-sharing mechanism. These grants can be in the form of grants-in-aid or specific-purpose grants.
• Borrowings:
  • Market Borrowing: State governments can borrow funds from the financial markets through the issuance of bonds and securities. These borrowings are an essential source of long-term financing for development projects.
  • Bilateral and Multilateral Loans: States may also seek loans and grants from international and national agencies for specific development programs.
  • Ways and Means Advances: The Reserve Bank of India provides short-term credit facilities to states to manage temporary mismatches in cash flows.
• Debt Management:
  • States are required to manage their debt prudently to ensure that it remains within sustainable limits. This includes monitoring debt levels, debt service obligations, and refinancing options.
  • Debt sustainability is essential to maintain favorable credit ratings and access to financial markets.