In the Indian federal set up, while the states have limited fiscal powers to raise resources, expenditure responsibilities for most local public goods and services are assigned to them. As a consequence, there is always a gap between the income and expenditure of the states. This gap is filled by revenue transfer from the Centre which includes both grants and a share in the central taxes. In addition to this, states, from time to time, also borrow from the market through state development loans.
The fiscal health of the state governments began deteriorating in the second half of the 1990s and continued till early 2000. Combined fiscal deficit of the states, at 4.5% of the GDP, peaked in FY00 and has improved thereafter. It has remained in the range of 2-2.5% of the GDP since FY06, with the exception of FY10. Combined revenue balance of the states has been positive since FY11. These fiscal numbers are certainly much better than the fiscal number of the Centre.
Despite adverse macroeconomic conditions, improvement in the fiscal health of state government finances are commendable, though a bit surprising. Sub-national revenues and expenditure are normally found to move in line with business cycles. However, RBI, in a panel data analysis covering the period of FY81 to FY13, found that fiscal expenditures of non-special category states in India exhibit different cyclical behaviour across different components. While capital outlay is found to be pro-cyclical, primary revenue expenditure turns out to be cyclical. This clearly shows the rigidity in adjusting such expenditure (which mainly consists of salary, pension, interest burden, etc) in tandem with growth cycles.
Revenue and expenditure
Notwithstanding the pro-cyclical behaviour of the capital outlay, the increase in the proportion of developmental expenditure of the statesí in total spending in recent years is a welcome change. Although there is still significant scope for the state governments to cut down the non-development expenditure, particularly subsidies, states which have accumulated revenue surpluses may utilise these to increase the capital outlay, particularly for infrastructure projects.
State governmentsí salary and pension burden increased sharply in FY10 and FY11, after the revision of the salaries of their employees in line with the recommendations of the sixth Central Pay Commission. However, after the salary revision process concluded in FY12, growth in salary and pension expenditure has been following a normal trend and is expected to do so till FY17-FY18 when the seventh Central