India’s fiscal Responsibility Rules

Context: States being at the frontline of our development efforts suffer from considerably high borrowing costs and may need greater flexibility in borrowing to achieve their goals.

Issues with sub-national fiscal policy

• High expenditure compared to Centre: The ratio of states’ expenditure as a proportion of total government expenditure is almost twice the global average. – International Monetary Fund.

• High borrowing cost: The weighted average of the borrowing costs of states has generally been higher than the comparable cost of central government borrowing.

• Kerala had to pay a premium of more than 200 basis points on long-term bonds when compared to the Union government.
• Crowding out by the Union government: The fiscal years 2009-10, 2013-14 and 2017-18 saw a sharp rise in the borrowings by Centre, increasing the costs for the states.
• India’s Greece problem: Fiscally conservative states do not have meaningfully lower borrowing costs than the more profligate states:
• Maharashtra’s highest fiscal deficit as a percentage of its State Gross Domestic Product (SGDP) has been 2.1%.
• On the other hand, Andhra Pradesh’s lowest fiscal numbers have been 2.6% of SGDP.
• This is large because investors know that all state government borrowings are implicitly backed by the Union government.
• Limitations of Fiscal Responsibility Laws (FRL): State governments have generally tried to keep their fiscal deficits within the limits imposed by their FRL.
• Yet, state debt burdens have been rising because of contingent liabilities.
• States have also been exposed to fiscal shocks.

Way Forward: 

• Review the states’ FRL: much the same way the Centre revised its Fiscal Responsibility Management Act in the 2018-19 Budget- debt was explicitly added as a target variable along with fiscal deficit.
• This is desirable because while the fiscal deficit of states remains well within their FRL threshold of 3%, the debt is rising at a high pace, crossing corresponding implicit thresholds.
• Auctioning of State development loans: This has reduced the borrowing costs for the states and reduced the interest rate of both short- and long-term bonds.
•  For E.g. Maharashtra could borrow at a modest premium of 26 basis point.