Clearing the fiscal mess

By S. Swaminathan

``Accumulated improvidence through unrestrained fiscal profligacy'' may not be a too severe form of disapproval of the way many State governments have been mismanaging their finances. The argument that the financial woes of State governments would not have arisen if only the system of fiscal devolution had revealed sufficient elasticity in relation to the increasing financial requirements of the States stemming from their developmental commitments is not entirely flawed.

Nevertheless, the framework of federal finance in India seems to have largely operated to the detriment of fiscal prudence, both of the Centre and the States. The result is that at the very time when the Centre is struggling to grapple with the almost intractable problem of mounting fiscal deficits, the States are clamouring for increased devolution of funds, not so much for financing developmental needs but for meeting ``revenue deficits'' or to put it differently, even for meeting their ``establishment costs.''

The crux of the crisis

Over the five years, 1995-2000, the fiscal deficit of all the States has galloped from Rs. 31,426 crores to Rs. 90,092 crores or at an annual average rate of more than 30 per cent. The revenue deficit has grown from Rs. 8,200 crores to Rs. 45,702 crores or at an annual average rate of around 90 per cent! In simple accounting language, what the State governments have been practising is the art of paying for their day-to-day expenditure through borrowing, from all possible sources including the Central Government and even some external aid.

Two factors stand out in this story of financial desperation of the State governments. First, the annual resort to market borrowing has increased from Rs. 7,847 crores in 1995-96 to Rs. 26,293 crores in 2000-01. All this notwithstanding the increased dependence on grants from the Centre which went up from Rs.20,996 crores in 1995-96 to Rs. 36,964 crores in 2000-01. Second, there has been practically no increase in States' own tax revenue as a proportion of total receipts which has stagnated at around 35.5 per cent.

The issue is not only that of unwillingness of State governments to explore the avenues of additional resource mobilisation but of inefficient and corrupt enforcement of the tax regime. All the explicit and implicit subsidies in power, irrigation, education and health besides the proverbially inefficiently-targeted food distribution, aggravate the fiscal malaise of the States.

Elusive search for a cure-all

The fiscal distress of the States, chronic as it is, needs to be treated over a period. There is no ``bail-out'' which the Centre can engineer even though the Eleventh Finance Commission came out, three years ago, with the concept of a ``monitorable fiscal reform programme for the States'' on an MoU (Memorandum of Understanding) mode.

What the Karnataka Government has recently announced - a Medium Term Fiscal Plan (MTFP) - could well serve as the guide-post for other States. It calls for a deft compromise between what is economically rational and what is politically feasible in such areas as expenditure management (with a focus on releasing funds for capital expenditure and for outlay on the social sector), recovery of user costs (in irrigation, power, education and so forth) and containment of interest burden through a gradual process of reduction of public debt.

It cannot be gainsaid that an MTFP has to be effectively anchored in a transparent, rule-based tax enforcement system which is conspicuous by its absence in many States where discretionary powers of the tax-gatherers have often robbed the State of its legitimate tax revenue. That the chances of an MTFP yielding the expected benefits will hinge crucially on the restructuring of public-sector enterprises at the State level cannot be overemphasised.

The States cannot obviously march into a condition of financial comfort during the medium term even with all the reforms required to be put through in governance unless the Centre positions itself such that additional Plan funding would be made available to the States, based on credible fiscal performance. The Planning Commission has rightly underscored the need for ``an annual fund'' to be set up at the Centre, for this purpose, in the context of the Tenth Plan.

In fact, the Commission has drawn attention to the dismal reality that the States have virtually no resources other than borrowings to finance Plan expenditure.

How the fragility of State finances has gone from bad to worse, over the last two decades, is vividly brought out by the Commission through the Draft Approach Plan to the Tenth Five Year Plan (2002-07). Between the Sixth Plan (1980-85) and the Ninth Plan (1997-2002), States' own contribution towards the financing of Plan expenditure has declined from 26 per cent to a negative 52 per cent while that of total borrowings has gone up from 35 to 107 per cent!

With all this, in many States, developmental paradoxes such as schools without classrooms, hospitals without doctors and medicines and engineers without new construction, continue to abound. The fiscal crisis in the States will not abate unless the State governments muster the political resolve and the economic wisdom required to match the developmental priorities with appropriate patterns of resource mobilisation and deployment. Blaming it all on the Centre can provide some illusory political escapism but not a sustainable course corrective!

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