The Reserve Bank of India (RBI) publishes its annual report on state finances to provide insights into the fiscal health of India’s state governments. This report is a crucial tool for policymakers, economists, and analysts to evaluate how states are managing their financial resources, how they compare against fiscal targets, and what challenges they are facing. The report is also an important reference for understanding the broader economic dynamics of the country.
Overview of the 2024-25 Report
The Report on State Finances 2024-25 by the RBI assesses the fiscal position of India’s 28 states and 8 union territories (UTs). The key areas of focus are:
- Revenue Growth:
- Both own tax revenues and central transfers
- Expenditure Management:
- Current vs. capital spending
- Fiscal Deficit and Debt Sustainability:
- Fiscal responsibility and borrowing limits
- Debt-to-GDP Ratio:
- Key indicator of the sustainability of state debt levels
The report also highlights the evolving fiscal policy landscape, challenges faced by state governments, and their strategies for dealing with economic slowdowns, inflationary pressures, and revenue volatility.
State Revenue Growth
State revenues in India come primarily from two sources: own tax revenues (such as VAT, sales tax, stamp duties) and central transfers (such as GST compensation, grants, and devolution of taxes).
- Own Tax Revenue:
- The growth in own tax revenues was mixed across states. Some states saw significant growth due to higher consumption levels and better tax administration, while others struggled with slower recovery in tax collections, exacerbated by weaker economic conditions.
- Central Transfers:
- Central transfers, especially through the Goods and Services Tax (GST) compensation and Finance Commission grants, continue to play a critical role in state finances. The report highlights that many states are still dependent on these transfers to meet their revenue targets.
Despite the growth in revenue for several states, the report notes the uneven recovery among states, with some lagging behind others in terms of revenue generation due to economic disparities and weaker tax compliance mechanisms.
Expenditure Management
Expenditure management remains a crucial area for state governments, as they need to balance essential spending on welfare schemes, infrastructure, and debt servicing.
- Revenue Expenditure vs. Capital Expenditure:
- States have been facing a persistent challenge in allocating resources between revenue expenditure (current spending, like salaries, pensions, and subsidies) and capital expenditure (spending on infrastructure and long-term growth). While revenue expenditure is necessary for running day-to-day governance, capital expenditure plays a critical role in fostering long-term growth and improving the state’s infrastructure.
- Social Sector Expenditures:
- A large portion of state spending continues to be directed toward social sector schemes such as healthcare, education, and welfare. While these expenditures are crucial for supporting vulnerable populations, the report indicates that many states have had to grapple with rising costs in these areas, especially as the pandemic-induced pressures continue to linger.
Fiscal Deficit and Debt Sustainability
One of the primary indicators of fiscal health is the fiscal deficit the gap between a state’s revenue and its expenditure. States must maintain a fiscal deficit within limits prescribed by the Fiscal Responsibility and Budget Management (FRBM) Act to ensure fiscal discipline.
- Fiscal Deficit Trends:
- The report points to an increase in fiscal deficits for many states during the past few years. While there was a recovery in the 2023-24 financial year post-pandemic, the fiscal deficit levels remain higher than pre-pandemic levels. Several states have also reported an upward revision of their deficit targets for 2024-25.
- Debt-to-GDP Ratio:
- The debt levels of states have been rising steadily, and the report expresses concern over the sustainability of state debt. While the Centre has allowed states to borrow more to help finance their recovery, excessive borrowing could have long-term implications for state finances. The report stresses the importance of fiscal consolidation and sustainable debt management.
The debt-to-GDP ratio is a key indicator for states to manage in order to avoid fiscal overreach. Some states have been able to keep their debt ratios under control, but others have breached the permissible limits, posing risks for future fiscal health.
The Role of Central Transfers and GST Compensation
- A significant portion of state revenues comes from central transfers, which have been a subject of concern for several states in recent years. The introduction of GST in 2017 altered the revenue-sharing structure between states and the Centre, leading to a decline in states’ share of revenues from indirect taxes. To mitigate this impact, the central government had promised a GST compensation scheme for states, which was extended for several years.
- However, as per the RBI report, states are facing uncertainties about the continuation and sufficiency of this compensation in the future, especially as the GST compensation period is nearing its end. This could create revenue shortfalls for states that rely heavily on these transfers.
Key Challenges and Risks
- Fiscal Deficit Management:
- Many states continue to face challenges in managing their fiscal deficits within the FRBM limits. These challenges are often aggravated by rising social sector spending, interest payments, and welfare commitments.
- Revenue Volatility:
- States with lower tax collections and reduced central transfers are facing higher risks of fiscal imbalance. The dependence on specific revenue sources makes states vulnerable to economic downturns and changes in central policies.
- Debt Sustainability:
- With increasing borrowing, the pressure on servicing debt continues to rise. The RBI has highlighted the importance of managing state debt carefully to avoid future fiscal crises.
Conclusion and Policy Recommendations
- The RBI Report on State Finances 2024-25 underscores the need for prudent fiscal management, emphasizing the importance of boosting own revenues, improving capital expenditure, and ensuring debt sustainability. States must continue their efforts towards economic diversification and better revenue generation to reduce their dependence on central transfers.
- At the same time, the RBI suggests that the Centre should provide additional support to states through infrastructure financing, GST reforms, and debt restructuring to allow states more fiscal space for growth and recovery.
- In summary, while states have shown resilience in the post-pandemic period, their fiscal health remains fragile. Addressing structural fiscal challenges, improving public sector efficiency, and prioritizing capital investment are essential for ensuring sustainable growth at the state level.
