The Union Government, RBI and Finance Commission should work together to enforce fiscal discipline in states, a research paper by the National Council of Applied Economic Research (NCAER) said.
The paper titled ‘The State of the States: Federal Finance in India’ further said heavily indebted states could be given some debt relief in return for conceding the Central Government oversight.
“The RBI should review its policies of intervening in the markets to cap spreads on the bonds of heavily indebted states. Limiting such intervention would strengthen market discipline,” the paper said.
According to the paper, there may be reluctance to move in this direction on the grounds that states should be treated equally, on borrowing costs just like other conditions, and for fear of contagion from the bonds of poorly performing states to the bonds of others that are innocent bystanders.
“But without market discipline, there can be no fiscal discipline,” it emphasised.
The paper also pointed out that the horizontal devolution of taxes among states, awarded by the Finance Commission every five years, does not provide incentives for fiscal rectitude.
“Perversely, Finance Commissions are mandated to allocate more resources to states with larger revenue deficits, which is an obvious source of moral hazard and a mechanism through which errant states are subsidized,” it noted.
The paper also suggested that there may be room for a fiscal “grand bargain,” where heavily indebted states with the worst prospects receive a modicum of debt relief (a portion of their debt is transferred to the balance sheet of the central government) in return for their conceding additional central government oversight and even a loss of fiscal autonomy.
The paper suggests a forensic analysis in worst-performing states to analyse what went wrong besides additional revenue mobilization by states through administrative streamlining and other measures like broadening tax base, raising property tax, adoption of new taxes and reorienting spending towards infrastructure and capacity-building.
It says the state governments should acknowledge the risk posed by contingent liabilities and address it by adopting institutional reforms for forecasting such liabilities and executing a debt management strategy.
India has the highest subnational debt as per cent of GDP among BRICS countries and the highest as a percentage of revenue of any country.
As per the paper, a third of India’s very considerable public debt is debt of the states, a large fraction by the standards of other federal economies.
State debts vary from less than 20% of state GDP in Odisha, Maharashtra and Gujarat to nearly 50% in Punjab.
In the last ten years, half of India’s larger states have added more than 10 percentage points to their debt-to-state-GDP ratios.
Of the rest, about half have exhibited fiscal prudence, while the other half have exhibited moderate levels of debt increase.
According to the paper, under the business-as-usual scenario, a majority of states will become even more indebted, and the financial condition of more and less indebted states will continue to diverge.
Except Gujarat, Odisha, West Bengal and Maharashtra, debt ratios have increased in all states from 2012-13 to 2022-23.
Published – February 12, 2025 06:46 pm IST
