Is Expenditure by States for Development Compromised to Ensure Compliance of Fiscal Targets? A Study of Indian States

Abstract

This article examines the interlinkage between fiscal consolidation targets and states’ developmental expenditure under capital account. While fiscal consolidation targets have enabled states to take corrective measures to reduce deficit under the revenue account, the effect of the same is studied on developmental expenditure under capital account. For analysis, the fiscal deficit and developmental expenditure under the capital account have been compared with the fiscal deficit targets and general category states’ average benchmarks for fiscal indicators for three phases (corresponding to the periods of three finance commissions). It is argued, that, while fiscal consolidation has helped to improve the state finances, the stringent fiscal targets have further reduced the developmental expenditure under capital account. In view of this, it is suggested that the states, which are historically stressed, should be allowed to borrow an additional amount of 0.25 per cent of GSDP each year over and above the existing limit, provided these states make efforts to reduce deficit under revenue account and spend the extra borrowings on developmental expenditure under capital account.

Keywords

Government fiscal policy public finance deficit debt sustainability public expenditure state budget deficit

JEL: H30, H62, H63, H72

1. Introduction

Fiscal consolidation measures have been undertaken by the centre and the states since the beginning of the year 2000. These measures, including the introduction of the Fiscal Responsibility and Budget Management Bill (Government of India, 2000b), have helped the centre and states in revenue mobilisation and expenditure rationalisation, which, in turn, has helped the governments to reduce deficits. The present study aims at analysing the effect of fiscal consolidation on a very important sub-national parameter, namely on states’ developmental expenditure under the capital account.

Public expenditure plays an important role in the economic development of a country. Increase in spending stimulates aggregate demand, which, in turn, increases national output through the mechanism of expenditure multiplier (Mondal & Maitra, 2020). Public expenditure is primarily of two types, developmental and non-developmental. Reserve Bank of India (RBI, 2017) defines developmental expenditure as expenditure on social and economic services (both revenue account and capital account). For the purpose of the study, we have considered RBI’s definition for developmental expenditure but have examined the effect of fiscal consolidation only on developmental expenditure on capital account. On the other hand, non-developmental expenditure normally pertains to expenditure on administrative services, law and order, etc.

On an average, from 2000–2001 to 2014–2015, developmental expenditure under the capital account of general category states (GCS) has grown from 2 per cent to 65 per cent annually. While annual growth in developmental expenditure under revenue account has been relatively constant, the developmental expenditure on capital account is found to be fluctuating. A study on developmental expenditure on social and economic services shows that while regional disparity has reduced over time, there are still huge differences in developmental expenditure undertaken across states (Aneja et al., 2020). Table A1 shows the annual growth rate for developmental expenditure under capital account for GCS for 15 years starting from 2000–2001. There was one outlier during the entire period (i.e., in 2003–2004). The fiscal year 2003–2004 saw a sharp increase in developmental expenditure, due to the one-time settlement scheme for dues of the state electricity boards (SEBs) and power bonds issued by 26 state governments to the central public sector units in September 2003 (with retrospective date of 1 October 2001) amounting to ₹289.84 billion (as per RBI records).¹

The Constitution of India has provided division of expenditure responsibilities and revenue resources between the union and states. State governments are responsible for the various activities such as providing social security, infrastructural development and also responsible for maintaining law and order within the state. A deteriorating state finance decreases the capability of states to make investment in a number of human development activities. The pressure has increased over time due to the rise in population, increasing expenditure on various activities involving social services and investment in the physical infrastructure of the states (Badaik, 2017).

Expenditure under revenue account and non-developmental expenditure are mostly committed in nature. Developmental expenditure under capital account is mostly discretionary, thus dependent on the fiscal space of the government. As can be seen in Figure 1, there are huge fluctuations in the average growth rate in developmental expenditure under the capital account for GCS. Since expenditure under this head is discretionary in nature, fiscal targets and resource constraints lead to fluctuations in the growth rate of such expenditure.

Figure 1.

Source: RBI Study of State Finances (2002–2017).

Multiple papers have studied the impact of imposition of fiscal rules on the finances of the government. In a study of budget deficits in OECD countries, it is observed that the government is more likely to reduce developmental expenditure for fiscal adjustments in the short run (Alesina & Perotti, 1995). In India, the capital expenditure of the central government declined drastically from 23 per cent of the total expenditure during the financial year 2004–2005 to 10.2 per cent in the financial year 2008–2009 (Anantha Ramu & Gayithri, 2017). In the Indian context, it is observed that fiscal rules have a negative impact on developmental expenditure (Chakraborty & Dash, 2013). It is observed that fiscal correction to a major extent has been through expenditure contractions (Sawhney, 2018). Rangarajan and Subbarao (2007) highlighted that for sustaining and accelerating growth, achieving the Fiscal Responsibility and Budget Management (FRBM) target is necessary, but it is not sufficient. Also, attention has to be paid not only to achieving the targets in quantitative terms but also with respect to the quality of adjustment. Lalvani (2009) mentioned that although the legislation has lowered the deficit of the states, and FRBM targets have been broadly met, the composition of expenditure has been altered. It is seen that for the GCS, revenue expenditure has remained stable at 12.90 per cent of gross state domestic product (GSDP) during both periods 2004–2005 and 2007–2008 (RE), while the share of capital expenditure has declined from 4.8 per cent of GSDP during the period from 2004–2005 to 3.8 per cent of GSDP in 2007–2008 (RE). This indicates that while the FRBM has been helpful in the improvement of states’ finances in terms of debt sustainability, the capital expenditure has been adversely impacted. In terms of composition, the share of revenue expenditure in the total expenditure has increased from 72 per cent in the period from 2004–2005 to 77 per cent in 2008–2009 (BE). However, this article has considered a brief period of 2004–2009 (BE), a timeline where not all states had implemented the FRBM targets. Also, during this period, the Indian economy was reeling under the global financial crisis, which led to the relaxation in the FRBM targets.²

The current study deviates from the earlier studies in several ways. First, the current study has assessed the interlinkages between fiscal targets and developmental expenditure under capital account, which has, by far, not been considered in earlier papers. The present article considers developmental expenditure under capital account because the fiscal multiplier of capital expenditure on economic growth is the highest (Bose & Bhanumurthy, 2015). In addition, it has been concluded that there is a need for promoting capital expenditure as an integral part of growth-promoting fiscal policy (Trivedi & Rajmal, 2011). Second, unlike earlier studies, this article analyses the relation between fiscal targets and the developmental expenditure under capital account undertaken by the states across different phases. The timeline of the study is divided into three phases, with phases corresponding to the periods of the three finance commissions, that is, 11th Finance Commission, 12th Finance Commission and 13th Finance Commission. The first period had no fiscal targets, followed by a period of relaxed targets and then to a period of stringent fiscal targets (Government of India, 2000a; 2005; 2010). This allows to assess the degree of changes in developmental expenditure under capital account based on the changing stringency of the fiscal targets. Third, this article also examines whether such targets should be uniform, considering that states are in different trajectories in terms of their capacity to raise revenue, expenditure responsibilities and social protection commitments. Finally, this study goes beyond the horizon of assessing the overall impact of fiscal targets on developmental expenditure and considers the effect of such targets on the fiscal health of individual states. A state-wise mapping of the fiscal deficit and developmental expenditure under capital account would enable in understanding how such targets are beneficial to certain states and extremely detrimental to others, depending on the socio-economic infrastructure and fiscal health of the states.

The rest of the article has been organised into seven sections. Section 2 discusses the initiation of fiscal consolidation measures in the country and its advancement over the years. Section 3 presents the trends in the growth rate of developmental expenditure under capital account for GCS. Section 4 discusses the timeline, methodology and data sources for the study undertaken, while Section 5 discusses the results of the study across phases. A case study on the effect of fiscal targets on West Bengal’s state finances has been undertaken in Section 6. Section 7 concludes the article.

II. Fiscal Consolidation Measures

The 1990s was a decade characterised by serious deterioration in union and state finances, which ended with a fiscal crisis (World Bank, 2005). During 1999–2000, fiscal deficit to gross domestic product (GDP)/gross state domestic product (GSDP) of the centre and the GCS stood at 5.4 per cent and 5.6 per cent, respectively. In the same year, both revenue deficit to GDP/GSDP of the centre and the GCS stood at 3.5 per cent, while debt to GDP/GSDP ratio stood at 59 per cent and 32 per cent, respectively. Deficits of this magnitude threaten solvency and lead to high committed expenditure due to increase in interest payments, further decreasing the fiscal space for developmental activities.

Fiscal consolidation refers to the policies and measures undertaken by governments (national and sub-national levels) to reduce their deficits, particularly fiscal deficit and revenue deficit and accumulation of debt stock. Such measures can be medium-term plans with defined fiscal targets or a one-off/temporary measure bringing immediate relief to finances. Thus, following the period of high debt of national and sub-national governments in the 1990s, both the union and states have undertaken multiple fiscal consolidation measures over the years. As a major step towards fiscal consolidation, the FRBM Act was introduced by the centre in 2000 and passed in 2003. This Act came into effect in 2004. It presented the dismal state of government finances both at the union and state level. The objectives of FRBM Act were elimination of revenue deficit by the fiscal period 2008–2009 and reduction of fiscal deficit to no more than 3 per cent of GDP at the end of the fiscal period 2008–2009. However, global financial crisis compelled the government to infuse resources in economy in 2008 and, therefore, fiscal targets had to be postponed temporarily in view of the global crisis. At the central level, the decisions to implement pay commission recommendations, extension of the National Rural Employment Guarantee and farm loan waiver schemes coupled with the sharp increase in the international price of crude oil in July 2018 severely impacted the fiscal balance of the government adversely.

Meanwhile, the sub-national governments were also undergoing a phase of poor fiscal health. At the turn of the century, the states were experiencing unsustainable debt trends and a squeeze on resources available for essential infrastructure development and provision of social services. Many states started undertaking fiscal correction measures. During the period 2000–2006, multiple states undertook fiscal correction measures through enhancing their own revenues rather than contracting expenditure (Ravishankar et al., 2008). The RBI (2006) highlighted that the fiscal deficit of all states, taken together, declined from 4.7 per cent of GDP in 1999–2000 to an estimated 3.2 per cent in 2005–2006. During this period, most states registered an increase in state’s own revenue, as well as a rise in the share of central resources (especially the poorer states), resulting from the awards of the 11th and 12th Finance Commission and contraction in non-interest expenditure. However, during this time period, West Bengal did not achieve any significant increase in own revenue. The own revenue to GSDP ratio increased only marginally from 4.45 per cent in 2000 to 4.89 per cent in 2006, and it remained the worst performing state on this account across the years.

Karnataka was the first state to enact the FRBM Act in September 2002, following which different state governments enacted the FRBM Acts across years. By the fiscal period 2006–2007, 22 of the 28 states had passed the fiscal responsibility legislations. The 12th Finance Commission had made the first recommendation on fiscal targets. It recommended that each state should enact fiscal responsibility legislation and stipulated the enactment of the legislation as a precondition for availing debt-relief scheme recommended by the Commission. In addition, the Commission recommended that the fiscal deficit to GSDP ratio should be targeted to be fixed at 3 per cent, and revenue deficits should be brought down to zero by the fiscal period of 2008–2009.

At the start of the 13th Finance Commission period, 12 states continued to have a revenue deficit, and 18 states had failed in fulfilling the fiscal deficit target of 3 per cent of GSDP. The 13th Finance Commission suggested that the revenue deficit of the states should be progressively reduced and eliminated, followed by revenue surplus by the fiscal period of 2014–2015. It also recommended that states that had eliminated revenue deficit by the fiscal period of 2007–2008 should achieve a fiscal deficit of 3 per cent of GSDP by 2011–2012 and maintain such thereafter. Other GCS needed to achieve 3 per cent fiscal deficit to GSDP by the fiscal period 2013–2014. In the fiscal period of 2013–2014, the revenue deficit and fiscal deficit of the GCS states was 0.2 per cent and 2.4 per cent of GSDP, respectively, while the revenue deficit and fiscal deficit of the centre was 3.1 per cent and 4.4 per cent of GDP, respectively.

Again, as per the 14th Finance Commission’s recommendations, the state’s fiscal deficit is proposed to be anchored to an annual limit of 3 per cent of GSDP. While flexibility was allowed over and above the 3 per cent, it was linked to the debt to GSDP and interest payment to revenue receipts ratio. Further, the FRBM Review Committee headed by Dr. N.K. Singh proposed a draft Debt Management and Fiscal Responsibility Bill, 2017, which proposed lowering of state debt to GSDP ratio to 20 per cent and debt to GDP ratio of the centre to 40 per cent by the fiscal period of 2022–2023 (FRBM Review Committee, 2017).

It is observed that, while these legislations have helped the states in reducing committed expenditure by rationalisation, it might have affected the capital expenditure adversely. Given the increasing burden of committed expenditure, fiscal consolidation recommendations made by the Finance Commissions and the introduction of FRBM along with limited revenue mobilisation scope due to the goods and services tax (GST), it is pertinent to assess the effect of fiscal consolidation, particularly the fiscal deficit target of 3 per cent of GSDP across GCS, on states’ developmental expenditure under the capital account, which depicts no trend pattern as presented in Figure 1.

In recent times, due to COVID-19, the target for fiscal deficit of sub-national government has been increased from 3 per cent to 5 per cent. While, out of 5 per cent, 3.5 per cent is unconditional, the next 1 per cent will be released based on four conditions of 0.25 per cent each. The four conditions relate to implementation of one nation, one ration card; reforms of power sector distribution companies; ease of doing business; and reforms in the area of urban local body revenues. The remaining 0.5 per cent will be allowed as soon as milestones are achieved in at least three conditions. However, this has been declared as a response to the COVID-19-led economic slowdown, and the adequacy of the same to combat relatively lower levels of developmental expenditure under capital account has to be analysed.

III. Trend in Growth in Developmental Expenditure Under the Capital Account of General Category States

Multiple studies have identified the importance of public expenditure positively impacting the growth of an economy (Lupu et al., 2018; Nworji et al., 2012).

Public expenditure in terms of social sector expenditure, total developmental expenditure, capital outlay and developmental expenditure under capital account has been analysed over different time frames. The phases have been defined as the time frames for the 11th, 12thand 13th Finance Commission. Thus, Phase 1 is 2000–2005, Phase 2 is 2005–2010 and Phase 3 is 2010–2015.

As is evident from Figure 2, while social sector expenditure and developmental expenditure show a rise in phase 3, the capital outlay and developmental expenditure under the capital account have shown a fall of 0.4 and 0.5 percentage points, respectively, during the same period. Also, in phase 2, most of the states had seen a revenue surplus, which allowed for more fiscal space for the states to make additional expenditure under capital account. This could be the reason for the rise in capital outlay and developmental expenditure under the capital account in phase 2.

IV. Methodology and Data Sources

Period Covered

Developmental expenditure under the capital account and the fiscal deficit of the GCS has been considered over 15 years starting from the fiscal period of 2000–2001. This period has been divided into three phases (one phase per Finance Commission starting from the 11th Finance Commission award period). Telangana has not been considered for the study since data for the same are available from the fiscal period of 2014–2015 onwards.

The study comprises three phases, namely phase 1 which is from 2000–2001 to 2004–2005 (11th Finance Commission period); phase 2 which is from 2005–2006 to 2009–2010 (12th Finance Commission period) and phase 3 which covers the period from 2010–2011 to 2014–2015 (13th Finance Commission period).

Figure 2.

Source: RBI Study of State Finances (2002–2017).

The launch of Ujjwal Distribution Company (DISCOM) Assurance Yojana (UDAY), in 2015, has purportedly increased the average fiscal deficit, expenditure on economic services and outstanding liability of the participating states (RBI, 2019). Hence, the post-UDAY period has not been considered for the current analysis.

Methodology

The primary objective of the analysis is to understand whether stringent fiscal targets set by FRBM Acts and Finance Commissions led to states compromising developmental expenditure under capital account, which is non-committed in nature. To understand the relation between fiscal targets on discretionary expenditure of sub-national governments, the fiscal deficit to GSDP ratio of GCS and developmental expenditure on capital account to GSDP ratio have been mapped for GCS. The mapping of the GCS in such a manner aids in understanding the correlation between the two variables and assists in further analysis of states’ limitations for undertaking such discretionary expenditure. The benchmark for fiscal deficit has been considered as the fiscal deficit target set by the respective Finance Commissions. There are no declared benchmark norms for developmental expenditure on capital account to GSDP ratio; thus, the periodic GCS average has been considered.

Figure 3.

Source: The authors.

The states were marked as compliant or non-compliant based on the comparison of the developmental expenditure under capital account and fiscal deficit to GSDP for all GCS with the decided benchmarks for each phase.

A quadrant-wise mapping of the states has been undertaken. As seen in Figure 3, states are plotted phase-wise into four groups, depending upon the performance of states across these parameters.

The states, which complied with Finance Commission recommendations on fiscal deficit but were below GCS average for developmental expenditure under the capital account to GSDP ratio in spite of the fiscal space available, were further analysed. The shortfall in developmental expenditure under the capital account to GSDP ratio for these states as against the GCS average has been calculated and added to the net borrowings of the state. The recalculated fiscal deficit to GSDP ratio has been compared to the fiscal deficit target of 3 per cent as recommended by the 12th and 13th Finance Commission. If the recalculated fiscal deficit to GSDP ratio is more than the fiscal target of 3 per cent, it is inferred that the fiscal targets proved to be binding on the states’ developmental expenditure.

Data Sources

The RBI Handbook of Statistics on Indian States and State Finances: A Study of Budgets for the period from 2002 to 2017 has been primarily used as data sources.

V. Results

A phase-wise analysis of developmental expenditure under the capital account to GSDP ratio as against fiscal deficit to GSDP ratio has been presented.

Key Findings Under Phase 1 (from 2000–2001 to 2004–2005)

Figure 4 shows the fiscal deficit to GSDP ratio and the developmental expenditure under capital account to GSDP ratio of GCS in Phase 1. Since there was no fiscal deficit target during this phase, the analysis is based on the states’ developmental expenditure under capital account. It can be seen that 8 states among the 17 GCS are below the assumed benchmark at 2.4 per cent (which is the GCS average for the concerned period). The first fiscal target recommendations were made in the 12th Finance Commission report for the period from 2005–2006 to 2009–2010; thus, no fiscal deficit targets were assumed for this phase.

During the period of 2000–2005, only certain states like Karnataka (2002), Kerala (2003), Punjab (2003), Tamil Nadu (2003) and Uttar Pradesh (2004) had passed their FRBM Act. Major fiscal consolidation initiatives across states only started in phase 2, that is, after 2005–2006. During phase 1, some states such as West Bengal, Punjab and Kerala were running a very high revenue deficit, which occluded a considerable part of borrowings to finance the deficit on revenue account.

Figure 4.

Source: RBI Study of State Finances (2002–2007).

Bihar and West Bengal were the two states that had the highest fiscal deficit to GSDP ratio during this phase. Bihar had the second highest fiscal deficit and a moderate revenue deficit, thus providing fiscal space for a high developmental expenditure. On the other hand, West Bengal had the highest fiscal and revenue deficit leaving very little scope for developmental expenditure.

Key Findings Under Phase 2 (from 2005–2006 to 2009–2010)

In the second phase, as seen in Figure 5, Maharashtra, Haryana, Gujarat, Odisha and Tamil Nadu had fulfilled the fiscal deficit target but failed to undertake developmental expenditure under capital account above the GCS average. In this phase, all GCS, except Haryana, registered a negative growth rate in developmental expenditure under the capital account. After the Electricity Act of 2003, Jharkhand mobilised its own regulatory commission, the Jharkhand State Electricity Regulatory Commission (JSERC), in 2004, which resulted in an increase of 128 per cent in loans and advances to the power sector. The high loans and advances in economic services led to both high developmental expenditure under capital account and high fiscal deficit.

On the other hand, West Bengal’s finances were still stressed with extremely high committed expenditure, comprising 70 per cent of revenue expenditure on average during the period, which continued to constrain the fiscal space for any significant increase in developmental expenditure under capital account. Interestingly, during the same period, Odisha has apparently constrained its revenue and capital expenditure to lower the deficit of the state and maintained developmental expenditure under capital account to GSDP ratio at around 2 per cent only, although it had the fiscal space to enhance it.

Figure 5.

Source: RBI Study of State Finances (2008–2012).

Figure 6 highlights fiscal deficit patterns of the states that failed both the fiscal deficit target (of 3 per cent of GSDP) and developmental expenditure under capital account benchmark (GCS average of 3 per cent) in phase 2. It is further seen from Figure 6 that if these 4 states undertook additional developmental expenditure under capital account up to the GCS average for the period, the fiscal deficit would have further gone up for Kerala, Punjab and Rajasthan under recalculated fiscal deficit figures during the period. For example, while Punjab had fiscal deficit to GSDP ratio of 3.2 per cent during phase 2, had Punjab undertaken developmental expenditure under capital account up to the GCS average, the projected ratio could have been as high as 4.7 per cent. It therefore appears that stringent fiscal targets had strained states to cut down discretionary expenditure.

Figure 6.

Source: RBI Study of State Finances (2008–2012).

Key Findings Under Phase 3 (from 2010–2011 to 2014–2015)

In phase 3, among the states which have failed to exceed the GCS average (of 2.5% of GSDP) for developmental expenditure under capital account but met the fiscal deficit targets (of 3% of GSDP), only West Bengal and Rajasthan registered a considerably high average year-on-year growth rate of 28 per cent and 24 per cent, respectively, on developmental expenditure under capital account As seen in Figure 7, only Punjab and Kerala exceeded the fiscal deficit target and remained below the GCS average for development expenditure under capital account.

Figure 7.

Source: RBI Study of State Finances (2013–2017).

During this phase, Kerala with the highest fiscal deficit to GSDP ratio and Madhya Pradesh with the highest developmental expenditure under capital account to GSDP ratio are at two extremes. During the period, Kerala was burdened with very high revenue deficit and consequent increase in the fiscal deficit, which restricted its developmental expenditure under capital account. On the other hand, during the same period, Madhya Pradesh had a high revenue surplus of 2.1 per cent of GSDP, thus enabling the state to undertake higher developmental expenditure under capital account and maintaining the fiscal deficit within FRBM limits.

Figure 8 highlights the states that met the fiscal deficit target of 3 per cent of GSDP but failed the developmental expenditure under capital account benchmark of 2.5 per cent of GSDP. The developmental expenditure under the capital account to GSDP ratio of these states is compared with the GCS average, and if the remnant amount of developmental expenditure to achieve the GCS benchmark of developmental expenditure under capital account to GSDP ratio is added to the net borrowing of the states, the fiscal deficit of these states grossly fails the fiscal deficit target of 3 per cent (except Goa, Maharashtra and Rajasthan) as shown in recalculated fiscal deficit to GSDP figures.

Figure 8.

Source: RBI Study of State Finances (2013–2017).

It thus appears that in phase 3, Andhra Pradesh, Haryana and West Bengal had spent less on developmental expenditure under capital account in order to meet the fiscal targets.

It can also be seen, in Figure 9, that states like Punjab and Kerala, which failed the fiscal deficit target along with the developmental expenditure benchmark targets, would also have failed the fiscal deficit target by a large margin, had these states undertaken developmental expenditure on capital account up to the GCS average level, as is evident from recalculated fiscal deficit to GSDP ratio. Punjab’s fiscal deficit to GSDP ratio could have been as high as 4.9 per cent had the state undertaken developmental expenditure under capital account up to the GCS average for the period.

Figure 9.

Source: RBI Study of State Finances (2013–2017).

VI. Scenario Development for West Bengal

To understand further the effect of fiscal consolidation targets on the sub-national developmental expenditure in view of the post-COVID-19 dire state of state finances, a case study for West Bengal has been conducted on the basis of projection of finances for West Bengal up to the fiscal period of 2025–2026. The effect on the developmental expenditure of the state is studied in light of the new fiscal targets. Also, the severe adverse effect to the economy in terms of lower revenue collections due to COVID-19 and the ensuing lockdown has been assumed. The finances for West Bengal have been projected with the following assumptions:

GSDP at current prices is projected to grow at a normative growth rate of 11.28 per cent in the fiscal year 2020–2021 to 16.75 per cent in the fiscal year 2025–2026.

Different types of taxes like state goods and services tax (SGST), State Excise, Stamp and Registration, etc., have been projected at a negative growth rate in the fiscal period of 2020–2021, followed by recovery in the fiscal period of 2021–2022 and then based on the buoyancy and GSDP growth rate.

Non-Tax Revenues to grow at (−)10 per cent in the fiscal year of 2020–2021, followed by recovery in the fiscal period of 2021–2022, and a growth rate of 7 per cent to 10 per cent from 2022 to 2026.

The impact of COVID-19 has also been considered for tax devolution; hence, a negative growth rate in the fiscal year of 2020–2021 has been assumed, followed by betterment in the fiscal period of 2021–2022, and a growth rate of 7 per cent to 12 per cent in the fiscal period of 2025–2026.

Grants from the centre has been projected in the range from 3 per cent to 6 per cent during the fiscal period 2020–2026.

Interest payment has been projected by first computing effective interest rate (effective interest rate is calculated to be 7.96 per cent in the fiscal period of 2019–2020 [RE]) and then applying the effective interest rate on previous year’s outstanding debt stock.

Salaries and pension have been projected by giving due consideration to the impact of the 6th Pay Commission

Two scenarios have been highlighted—one where the state incurs developmental expenditure under capital account as per normal trend vis-à-vis requirement of the state, and the other where debt stock to GSDP ratio is capped at 25 per cent by the fiscal period of 2025–2026. As seen in Figure 10, for a state like West Bengal, which is recovering from past fiscal mismanagement before 2011, and reeling under the impact of COVID-19, the fiscal target of debt stock to GSDP ratio of 25 per cent is simply unachievable. As highlighted, the economic impact of COVID-19 will affect the state’s finances for years; thus, even if zero developmental expenditure under capital account is undertaken, reducing debt to GSDP ratio to 25 per cent in the fiscal period of 2025–2026 is not viable. Table 1 depicts West Bengal’s projections if debt to GSDP ratio is reduced to 25 per cent by the fiscal period of 2025–2026.

Figure 10.

Source: The authors.

VII. Concluding Observations

The study concludes that across 15 years starting from the fiscal period of 2000–2001, various states compromised on their developmental expenditure under capital account due to the pressure that has been created by way of fiscal consolidation. It is also argued, in view of the uneven performance of the states on the fiscal deficit to GSDP and developmental expenditure under capital account to GSDP parameters used in the current study, a uniform measure of fiscal consolidation across the states should not be treated as a panacea. In spite of the capacity of many states to borrow more without hampering sustainability, states had cut down on developmental expenditure under the capital account due to the fiscal targets. The current study suggests that fiscal targets had an adverse effect on states like West Bengal and Andhra Pradesh.

Instead, states which have low developmental expenditure under capital account, historically owing to stressed finances, should be selected on the basis of their capacity to take further debt. These states should be allowed an additional borrowing of 0.25 per cent, over and above the FRBM limit allowed to all states in general, on certain conditions that not only substantiate the utilisation of additional borrowing allowed but also showcase their efforts of revenue mobilisation and expenditure rationalisation. The conditions under which such relaxation of FRBM target of fiscal deficit to GSDP are allowed to such states may include the following conditions:

additional borrowing should be spent solely on developmental expenditure under the capital account on the basis of a pre-approved developmental agenda that links important state-specific social and economic sector outcomes;

fund utilisation report to be submitted against the 0.25 per cent additional borrowing;

considerable efforts have gone into reducing revenue deficit and attaining surplus thereon;

In addition, the ratio of developmental expenditure under capital account to GSDP may be monitored to increase by at least 0.25 per cent for the following year. This will not only increase the developmental outcomes of these states but also ensure that the states can continue with the developmental expenditure without additional support.

Table 1.

West Bengal Projections if Debt: GSDP Ratio Is Reduced to 25 per cent by 2025–2026 (in ₹ crores).

	2020–2021	2021–2022	2022–2023	2023–2024	2024–2025	2025–2026
GSDP (at current prices)	1,424,295	1,639,648	1,869,363	2,159,114	2,507,163	2,927,113
Normal scenario (post-COVID-19)
Developmental expenditure under capital account: GSDP (%)	1.6	1.9	2.4	2.9	3.3	3.8
Debt: GSDP (%)	36.8	37.0	38.0	38.8	39.6	40.4
If Debt is restricted to 25% by 2025–2026 (post-COVID-19)
Developmental expenditure under capital account: GSDP (%)	0.0	0.0	−0.3	−0.5	−0.6	−0.7
Debt: GSDP (%)	35.2	33.5	32.1	30.1	27.6	25.0

Source: The authors.

Appendix A

Table A1.

Year-on-year Growth Rate of Developmental Expenditure in Capital Account (in %).

States	2001–02	2002–03	2003–04	2004–05	2005–06	2006–07	2007–08	2008–09	2009–10	2010–11	2011–12	2012–13	2013–14	2014–15
Andhra Pradesh	16	1	16	23	25	25	50	−12	12	−6	29	2	−3	−34
Bihar	–13	41	20	−22	66	43	15	10	17	24	2	8	23	24
Chhattisgarh	134	70	80	−12	32	61	22	−6	7	−3	52	27	−15	13
Goa	−6	11	40	29	36	12	10	25	21	12	−3	−18	1	14
Gujarat	−51	38	116	−16	61	8	−12	46	−21	22	37	55	5	5
Haryana	1	−52	236	−63	61	50	42	31	27	−22	26	5	−27	−4
Jharkhand		6	–2	41	31	25	12	−9	2	5	−28	44	3	26
Karnataka	5	36	13	32	16	46	6	12	25	16	14	−4	7	14
Kerala	−13	31	109	−56	24	17	91	14	9	40	17	19	0	−13
Madhya Pradesh	48	42	–2	185	−10	−18	31	7	38	6	100	−32	−6	54
Maharashtra	−11	17	92	2	38	–14	−1	61	−8	2	−3	0	15	−4
Odisha	−18	15	75	−52	−10	51	97	23	−4	22	8	17	41	43
Punjab	23	−65	96	−48	102	102	−29	31	−24	9	−31	24	10	47
Rajasthan	12	13	80	0	14	7	19	9	−2	−14	50	60	10	15
Tamil Nadu	18	0	103	21	−6	61	12	30	−12	35	55	−13	0	12
Uttar Pradesh	−3	8	142	−42	51	57	20	30	14	−20	6	9	32	66
West Bengal	−10	−31	11	35	−10	15	13	17	−17	−30	22	76	34	37

Source: RBI, State Finances: A Study of State Budgets (2002–2017).

Footnotes

Acknowledgements

The authors are extremely grateful to ARTHANITI’s anonymous referee for his/her insightful comments and suggestions.

Declaration of Conflicting Interests

The authors declared no potential conflict of interests with respect to the research, authorship and/or publication of this article.

Funding

The authors received no financial support for the research, authorship and/or publication of this article.

Notes

References

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