Economic Survey 2016-17: Chapter-06: Fiscal Rules: Lessons from the States

In chapter 6, the survey has focussed on the states and has analyzed the role played by Fiscal Responsibility Legislations (FRLs) towards their Fiscal discipline along with other factors  that contributed in containing fiscal deficit and lessons to be learnt for future fiscal rules.

Fiscal Responsibility Legislations

The FRBM Act, 2003 mandated the central government to take certain measures to contain its fiscal deficits and present certain documents with the budget documents in parliament. This law was not for the states. In the 10th plan, the planning commission highlighted the need for the states also to enact their own laws to reduce the overall debt-GDP ratio of India. Following such advices, some states such as Karnataka, Kerala, Punjab, Tamil Nadu, Maharashtra etc. have enacted their Fiscal Responsibility Legislations {FRLs}. These laws have imposed Fiscal discipline in states through various measures such as:

• Fixation of fiscal Target: For example overall deficit not to exceed 3% of GSDP and; revenue deficit to be eliminated by certain year.
• Market Borrowings: The 12th finance commission had allowed states to borrow from market in order to exercise discipline through investors, who will push up the interest rates on states whose fiscal position is not good.
• Annual report to project deficit: The states were required to publish annual Medium-Term Fiscal Policy reports which would Project deficits over the next three to four years

The survey says that in last few years, the states have achieved fiscal targets in advance of the year 2008. In these states, the fiscal deficits fell to almost half while revenue deficit was almost eliminated. However FRL is not the sole reason of states deficit reduction there are other exogenous factors too that contributed in state achieving fiscal target. These exogenous factors  include:

• Increase in central transfers to states
• Increase in tax revenues due to GDP growth and VAT adoption
• Debt restructuring programmes which led to fall in interest payments
• Increase in non-interest revenue expenditures, which implies that the states used revenue gains to bring down deficits rather than ramping up the spending.

Assessment of FRL and Lessons to be Learnt

The above discussion makes it quite clear that though FRL brought changes in outcome and behavior by improvement in budget forecasting procedures and a reduction in debt, but much of the improvement in financial positions was possible because of exogenous factors, most notably assistance from the centre in the form of increased revenue transfers, the assumption of state debt, and the introduction of centrally sponsored schemes.

Coming to the conclusion, the survey says that role played by FRL has been more subtle because a few years after the FRL, all indicators of fiscal performance—deficits, expenditures, and especially off-budget activities—started  deteriorating. It is possible that the Centre has prevented this deterioration by exercising Article 293 (3) of the Constitution which says that States must take consent of the Centre for additional borrowing. The survey has asked the union government to help states face fiscal challenge such as Pay Commission recommendations, slowing growth, and mounting payments from the UDAY bonds, there is need to review how fiscal performance can be kept on track. It has asked the government to also implement 13th and 14th finance Commission recommendations.