With outstanding debts exceeding the prudential threshold, the RBI urges states to adopt “next-generation” fiscal rules to ensure sustainable financial management

According to a report on ‘State Finances: A Study of Budgets of 2024-25’ released by the Reserve Bank of India (RBI) on December 19, 2024,  the consolidated gross fiscal deficit (GFD) of all State governments was contained within 3 per cent of their gross domestic product (GDP) during the financial years (FY) 2022-23 and 2023-24. For 2024-25, their GFD has been budgeted at 3.2 per cent of GDP. They have complied with the stipulation under the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 which requires them to keep it within the 3 per cent cap. But, the good news ends here.     The report reveals that the total outstanding liabilities of States were 28.5 per cent of the GDP in March 2024. Though lower than the peak of 31 per cent reached as of March-end 2021, it remained significantly above the prudential debt-GDP ratio of 20 per cent mandated for the states under the Act.

Another measure of how a State government is managing its budget is its revenue expenditure (RE) about capital outlay (CO). While, the RE being on items such as salaries, wages, pension bills, subsidies etc essentially goes towards non-asset creating spending, CO results in the generation of capital assets thereby providing a foundation for income stream over some time. Greater emphasis on the latter is considered fiscally prudent whereas more of the former can lead to fiscal destabilisation. The record of many states on this crucial parameter is disconcerting.  For all states, the total expenditure increased from around Rs 3428,000 crore in 2020-21 to Rs 5760,000 crore during 2024-25 (budget estimate). As regards RE, it increased from Rs 3018,000 crore in 2020-21 to Rs 4840,000 crore in 2024-25. The CO increased from Rs 410,000 crore during 2020-21 to Rs 920,000 crore during 2024-25. These numbers yield a ratio of RE to CO or RECO of 5.2 (4840,000/920,000).

In several states, the RECO is much higher than even this national average. For instance, in Punjab, at 17.1 it is more than three times followed by Puducherry (14.1), Kerala (10.6) and Delhi (10.3). There are some better-performing states too such as Manipur having the best ratio (2.4), followed by Gujarat (2.9) and Sikkim and Arunachal Pradesh (3.1). However, the abnormally high RECO of other states pushes up the national average.

How does it compare with the Centre?

The total expenditure of the Central Government increased from Rs 3042,000 crore during 2020-21 to Rs 4820,000 crore during 2024-25. Of this, the RE increased from Rs 2603,000 crore during 2020-21 to Rs 3709,000 crore during 2024-25. On the other hand, its CO increased from Rs 439,000 crore during 2020-21 to Rs 1111,000 crore during 2024-25. So, RECO for the Centre is 3.3 in 2024-25 (3709,000/1111000) against 5.2 for the States.

Barring a couple of good performers like Gujarat which is doing even better than the Centre, most of the states have been reckless in their revenue spending and that includes a sharp rise in expenditure on subsidies. Since 2018-19, subsidies given by the states have grown 2.5 times to over Rs 470,000 crore being the budget estimate for FY 2024-25), The RBI cites farm loan waivers, free or subsidised services like electricity, transport, gas cylinders, and cash transfers to farmers, youth and women as key areas of incipient stress. It suggests that states need to adopt “next-generation” fiscal rules, time-bound glide paths for fiscal consolidation, and rein in subsidies and freebies so that it doesn’t crowd out more productive expenditures. Such exhortations have been made umpteen times in the past not just by the RBI but also by several committees set by the government on ‘expenditure reforms’ from time to time.

Now, we have more jargon like “next-generation” fiscal rules to convey the same message with greater intensity.

The RBI posits these rules as “combining the medium-term fiscal sustainability objective with short-term flexibility allowing state governments more maneuverability in dealing with exogenous economic shocks”. The banking regulator goes on “these will involve inter alia, the use of data analytics, including machine learning (ML) and artificial intelligence (AI); improved data transparency and disclosure practices; and strengthening the institution of State Finance Commissions to deliver public services more effectively and scale up social and physical infrastructure,” Put simply, the RBI expects the State governments to not just bring about policy reforms and refinements to better target welfare schemes – focusing primarily on the poor sections of the society but also to galvanise the administrative machinery and institutions to deliver benefits efficiently and prevent misuse/diversion by making the best use of technology interventions.    

Do the States understand? 

The answer is a categorical ‘no’. Forget a finely crafted system desired by the RBI and government committees, most of the states have put in place crude and non-transparent subsidy regimes call them freebies - a jargon for “something given free of charge” – all aimed at alluring voters and winning elections. The political parties have sought to cover under ‘something’ literally everything that touches the life of a person.

It includes free food, free health, free education, free LPG cylinder, free laptops, free transport, state support for marriage, and pilgrimage for the elderly; it’s an unending list. 

In the last couple of years, the freebies promised by them have become more brazen with parties coming out with ‘cash transfers’ to the account of voters. Such schemes mostly directed at women have won elections for the concerned parties in elections held during 2023 and 2024 in Madhya Pradesh (MP), Rajasthan, Chhattisgarh, Maharashtra, Jharkhand and Haryana. The parties compete with each other in offering more. A common refrain is ‘Who will promise more”?    

Look at this. In the budget for 2024-25, Delhi finance minister Atishi announced the Mukhyamantri Mahila Samman Yojana (MMSY) under which, the AAP government will give Rs 1000 per month to all the women above the age of 18 in the national capital. Now, ex-Chief Minister Arvind Kejriwal has increased the amount to Rs 2100 per month.

In response, the BJP has reportedly promised a still higher cash transfer of Rs 2500 per month.  Let us be clear. Unlike ‘normal’ budget expenses which are planned and backed by well-orchestrated efforts to garner revenue, additional financial liabilities imposed by the freebies promised in the election manifesto affect the budgetary position of the State in a totally ‘uncontrolled’ and ‘unplanned’ manner. Moreover, these freebies don’t have a sunset date meaning these will continue to be given ‘eternally’ – no matter which party rules. This is the surest invitation to fiscal catastrophe. Take the case of Delhi.

Already, without the MMSY, the financial position of the Delhi government has come to such a pass that CM Atishi has recently forwarded a request to the Centre seeking a loan of Rs 10,000 crore from the National Small Savings Fund (NSSF). Now, if AAP were to come to power yet again, MMSY @Rs 2100 a month would cost the exchequer an additional Rs 17,000 crore per annum.

Since 2018-19, state subsidies have grown 2.5 times to over Rs 470,000 crore (2024-25), courtesy freebies cult. This will increase exponentially, destabilising State budgets, and making a mockery of the much-touted fiscal consolidation drive. The Supreme Court has on several occasions observed that ‘freebies are bad’. Will it force parliamentarians to enact a law to curb them?

(The writer is a policy analyst; views are personal)