With states accounting for a third of India’s burgeoning public debt and only about half of them exhibiting fiscal prudence, a National Council of Applied Economic Research (NCAER) paper has recommended that the Finance Commission use fiscal “grand bargain” for debt relief to heavily indebted states in return for conceding additional central government oversight.
‘The State of the States: Federal Finance in India’ report by NCAER points to reforms to strengthen fiscal discipline at the state level as high level of public debt limits their ability to fund social and developmental needs. One of the key recommendations of the authors is to enhance institutional capacity, with each state creating its own independent fiscal council comprising academics, financial market participants and other experts. Their reports would assess the realism of state government forecasts of revenues and expenditures and offer forecasts of their own.
Another is that the RBI should review its de facto practice to cap spreads on the bonds of heavily-indebted states to strengthen market discipline.
“Without market discipline, there can be no fiscal discipline,” according to the paper.
It has recommended a few tweaks in the mandate of the Finance Commission as well. “Finance Commissions have never considered overall fiscal prudence when recommending allocations. The horizontal devolution of taxes among states, awarded 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, a mechanism which ironically subsidizes errant states,” says the paper.
Pointing to the room for a fiscal “grand bargain”, the paper has suggested that “heavily indebted states with the worst prospects could be given a modicum of debt relief in return for their conceding additional Central Government oversight and even a temporary dilution of fiscal autonomy”. State debts in India vary from nearly 50% of state GDP in Punjab to less than 20% in Odisha, Maharashtra and Gujarat. In the last 10 years, larger states have added more than 10 percentage points to their respective debt-to-state-GDP ratios. Debt ratios have risen in all but four states over the last decade.