"Limits need to be placed on borrowing levels of both centre and state governments to curtail the deficit," Chidambaram said addressing a seminar on "restructuring of government finances: issues before the eleventh finance commission," organised by the National Institute of Planning and Policy (NIPP).

Though states cannot borrow without centre's permission, in the past they were able to convince the centre through political pressures and various other reasons to borrow more than the planned or set levels, he pointed out.

A legislation limiting the borrowing powers of government would ensure that no frequent changes were made in the budget, he added.

At the same time, there was need to raise more resources through the tax route, Chidambaram said adding an exercise to raise direct tax collections hadalready been made and what was needed now was a serious excercise on indirect taxes front. Article 292 of the constitution allowed fixation of a ceiling by parliament on the extent of borrowings by the centre and also giving guarantees within such limits, Chidambaram said.

Similarly, Article 293 allowed fixation of limit by the state legislature on giving gurarantees.

B Bhatacharya of the Indian Institute of Economic Growth said there was need to reduce the gap between the cost of raising funds and the rate of return on investments made from these resources.

"While the cost of governmnt borrowing has risen over the years, there has not been a commensurate rise in the returns resulting in a debt subsidy," he said.

Government needs to look at ways to borrow at lower rates and thus lower the rate of debt subsidy, he said.

Earlier, speaking at the seminar AL Verma, an economist, pointed out that the quantum of states over the last few years had reached the level of 20 per cent of the country's GDP andthe percentage of revenues used for interest payments on an average had risen from 7.5 per ent in 1980-81 to 17.6 per cent in 1997.

The state governments should be asked to contribute towards a sinking fund, resources out of their present earnings to meet the repayment pressures in future, he suggested. Ravi Mohan of Crisil, a rating and advisory agency, said there was a wide disparity in economic structures of various states but most of them were faced with rising deficit levels and deteriorating interest coverage position.

A major lacunae in the present system was that contingent liablities like that arising on account of the pay commission are not reflected at the time of consolidation.

Citing the example of power purchase agreements signed by various states, he said "for every PPA signed for 1000 mw of power, a state will have an additional liablitiy to the tune of Rs 2000-2500 crore. This has not been taken into account."

Similarly obligations in the form of guarantees or special purpose vehicleshave to be borne by the states, he said, adding the states are not being compensated for this additional burden.

A limit on the contingent liablities needs to be put in place, he said.

Resources to meet these additional obligations can be raised by state entities like municipalities by exploiting their strengths, he said.

Moreover, the revenues raised by these municipalities can be utilised only for specific purposes and not diverted for any other purpose than raised, he said.

Mohan also suggested introduction of a capital charge concept to convert guarantees and contingent liabilities into debt.