As India Slips Into Election Mode, Populist Sops Put Spotlight Back On State Finances

Will the projected growth and revenue buoyancy indeed improve the pandemic-impaired health of state finances? On the surface, the answer may be in the affirmative. However, a deep dive would point to a more complex reality.

The five assembly polls in the next one month and the general election next year will undoubtedly bring forth the vulnerability of the states as political parties make tall promises to cater to their carefully identified vote banks. A raft of freebies have already been promised for the assembly polls in Rajasthan, Madhya Pradesh, Telangana, Chhattisgarh and Mizoram; more will be pledged as campaigning peaks for the highly competitive Lok Sabha polls early next year.

Unmindful of the petition pending before the Supreme Court against pre-election sops, most political parties have announced freebies like free gas cylinders, pension to women, stipend to students and free electricity in the five states. Before the model code of conduct was notified, Madhya Pradesh hiked the salary of government employees and announced sops and freebies, piling up a financial burden of Rs 25,000 crore on the state exchequer.

In Rajasthan, the Ashok Gehlot government has promised “five guarantees” to the voters. These include free laptops or tablets to students and a minimum price for cow dung. It has also announced subsidies on cooking gas cylinders and free electricity to farmers. Chhattisgarh has promised a monthly unemployment allowance of Rs 2,500 to those with family incomes below Rs 2.5 lakh a year.

Telangana’s BRS government announced a Rs 5,800-crore crop loan waiver to 90,283 farmers having debts under Rs 1 lakh. The Congress has promised a monthly allowance of Rs 2,500 for women, gas cylinders at Rs 500 each, free transport on state buses for women, Rs 15,000 a year for farmers and Rs 12,000 for agricultural labourers in Telangana.

Tasked with ensuring a free and fair election, Chief Election Commissioner Rajiv Kumar recently described the competitive rush to announce freebies as 'tadka' of populism and said it becomes very difficult for parties to implement these sops once they win. He said the parties don’t remember these sops for five years but announce them a month or a fortnight before the election dates are announced.

Mounting Debt

A study by the Reserve Bank of India has found that five states - Bihar, Kerala, Punjab, Rajasthan and West Bengal – are highly stressed owing to their high debts. At least three of them are chronically stressed. Five more states - Andhra Pradesh, Haryana, Madhya Pradesh and Uttar Pradesh - are vulnerable.

Data crunched by The Secretariat shows that 9 of 20 Indian states (excluding Jammu-Kashmir, Goa and the states in the northeast other than Assam) are under severe stress, meaning their fiscal deficit was higher than FRBM mandated target of 3 per cent of GDP and their debt to GDP ratio was more than 30 per cent. (See chart)

The high debt burden on these states has resulted in unbearable interest costs; high fiscal deficit and low capex. Their revenue expenditure – on salary, pension and interest payments – has burgeoned to as high as 90%, leaving them with thin resources. Having no resources for capital expenditure means compromising with growth-inducing assets, productivity and future revenue.

What are the key risks that may further deepen the crisis of state finances? Will the new indirect tax regime of GST, which has lately seen buoyant growth, come to their rescue? What can states do to bolster their non-tax revenue collections?

Experts are divided on what led to this situation. Some blame the states for taking irresponsible fiscal actions, often driven by political expediency. Others believe the Centre has unfairly squeezed out revenues due to the states. However, there is a consensus that the Centre and the states must come together urgently to address the crisis staring at them.

One of the major risks relating to the financial health of states is the decision of some governments to bring back the Old Pension Scheme, which essentially is a deferred liability, or incurring more liability than the revenue receipts of the exchequer. Many states have recently made such promises and such a decision is going to bore a big hole in the tattered state of treasuries.

Promising freebies prior to polls is a common thread which runs through all political parties and implementing them takes a huge toll on the treasuries. Unmanageable salary and pension load is another risk.

Take the case of Punjab, undisputedly the most precariously placed. According to VK Garg, a former advisor to the Punjab government, salaries and pension payments account for almost 93% of the state’s revenue receipts. Punjab also stands out in terms of committed expenditure, which is about 75% of total expenditure as against the national average of 55%.

While unsustainable spending decisions are a major cause of deteriorating fiscal health of the states, they have also been denied a fair share in tax revenues as the Centre continues to levy new cess and surcharges.

Rajgopal Devara, additional chief secretary (revenue) in the Maharashtra government, points out that 19.8% of the gross revenue receipts of the central government are raised through cess and surcharges that are not a part of the divisible pool. Worse, there has been very little effort to increase non-tax revenue, which is just about 1.3% of GDP, according to Garg.

There are many services that states provide for a fee. Such user fees can be increased to mobilise additional revenue, which may not be large but can provide some relief. Many user fees have not been revised for decades. It is imperative that user fees are inflation-adjusted.

Other potential sources of revenue could include augmenting rental income from state PSU assets and monetising data available with state governments, which can be of interest to the private sector. Of course, the concerns around data protection and privacy must be taken into account before any such attempt.

In short, if India is to become a $5 trillion economy, the Centre needs to reform the devolution process and the states need to reform their strategic thinking and carve out more avenues for non-tax revenues. This is, perhaps, the only way to avoid the risky terrain of fiscal deficits and rising debts.

(Shailendra Kumar is the founder-editor of web portal www.taxindiaonline.com. Views expressed are personal)