Date : 20/09/2023

Relevance – GS Paper 3 – Indian Economy

Keywords – Fiscal performance, GSDP, non-tax revenues, fiscal deficit

Context

In a recent report published by a leading multinational German investment bank, the fiscal health of 17 key states in India was assessed based on several crucial parameters. This comprehensive study evaluated the states' fiscal performance by examining fiscal deficit, own tax revenue, state debt levels as a percentage of gross state domestic product (GSDP), and interest payments to revenue receipts. The findings shed light on the state's economic well-being, with Maharashtra and Chhattisgarh emerging as top performers.

Fiscal Health Assessment:

The report's assessment of fiscal health in Indian states provided valuable insights into their economic standing. The four primary parameters used for evaluation were fiscal deficit, own tax revenue, state debt levels as a percentage of GSDP, and interest payment to revenue receipts. These metrics collectively offer a comprehensive view of each state's financial condition.

Top-Performing States:

1. Maharashtra: Maharashtra secured the top position in fiscal health. Its strong performance can be attributed to efficient fiscal management and robust economic activities.
2. Chhattisgarh: Chhattisgarh stood out as the second-best state in terms of fiscal health, showcasing its prudent financial policies.
3. Telangana: According to the FY24 first budget estimates, Telangana ranked among the top three states, highlighting its favorable economic outlook.

Underperforming States:

Bengal, Punjab, and Kerala: These states found themselves at the bottom of the fiscal health ranking, indicating the need for substantial improvements in their financial management.

Fiscal Deficit and Government Borrowing:

Fiscal deficit is a critical indicator of a state's financial health. In India, states contribute significantly to government revenue but also account for a substantial portion of government spending, with approximately 60% of combined government expenditure. The report highlighted that at the Union Government level, fiscal deficit had decreased from 9.1% of GDP in 2020-21 to 5.9% in 2023-24 (Budget Estimates, BE). For major states, it was expected to be 2.9% of GDP in 2023-24 (BE).

The Fifteenth Finance Commission proposed a glide path to reduce the fiscal deficit for both Central and state governments. The recommended limits for states as a percentage of GSDP were 4% in 2021-22, 3.5% in 2022-23, and 3% during 2023-26, with an additional 0.5% allowed for power sector reforms.

The aftermath of the pandemic saw a surge in the consolidated gross fiscal deficit (GFD) of states, reaching 4.1% of GDP in 2020-21, the highest since 2004-05. However, this spike was followed by a surprising reversal due to higher-than-expected growth in tax and non-tax revenues. By 2021-22, the GFD had decreased to 2.8% of GDP.

Revenue Augmentation Measures:

The report highlighted the proactive measures taken by state governments to augment their revenues, particularly in response to the pandemic's economic impact. Some states, such as Kerala, Rajasthan, and Maharashtra, introduced amnesty schemes to provide relief to taxpayers and improve revenue collections. Punjab proposed the establishment of a Tax Intelligence Unit to enhance GST compliance, while Chhattisgarh initiated the "Karai Vardhan Cell" to boost revenue through data-driven analysis of taxation acts and rules.

Other revenue-generating measures included liquidation schemes in Assam, one-time schemes for settling old VAT dues in Haryana, and the introduction of a Green tax in Assam and Kerala to discourage the use of old vehicles. Additionally, Haryana adopted measures for phased asset monetization.

Despite these revenue-boosting efforts, the states witnessed a significant increase in revenue expenditure, especially in essential sectors such as healthcare and rural development, to support vulnerable populations during the crisis.

Investment Activity:

India boasts one of the world's highest investment rates, with a capital investment/GDP ratio of 31.2% in 2021, surpassing other BRICS nations. Households and private corporations collectively contribute over 70% to gross capital formation in the country.

Several states have actively encouraged investments in emerging sectors, with a focus on nurturing start-ups and supporting the electric vehicle (EV) manufacturing industry. States like Chhattisgarh, Goa, Haryana, Maharashtra, Kerala, Punjab, and Rajasthan have introduced various incentives for EV start-ups.

Additionally, states such as Bihar, Goa, Karnataka, Uttar Pradesh, and Delhi have implemented policies to create a conducive environment for start-ups, offering infrastructure facilities, co-working spaces, R&D and testing labs, incubators, accelerator programs, and financial assistance.

Foreign Direct Investment (FDI):

Historically, Maharashtra has been the top-performing state in terms of FDI over the past two decades. However, recent years have witnessed a shift in favor of other states. Factors contributing to Maharashtra's attractiveness for foreign investors include its status as the financial capital of India, high GSDP growth rates, robust infrastructure development, and an "Ease of Doing Business" environment.

In the financial year 2020-21, Maharashtra slipped to the second position, trailing behind Gujarat in FDI inflows. The trend continued in 2021-22, with Maharashtra again securing the second spot, lagging behind Karnataka. However, in 2022-23, Maharashtra reclaimed its position as the leading destination for FDI, receiving the highest investment. The computer hardware and software, automobile industry, and the services sector were the primary recipients of FDI inflows.

Maharashtra's resurgence as the top investment destination not only bodes well for its own economic growth but also contributes significantly to India's overall GDP. Niti Aayog's inclusion of the Mumbai Metropolitan Region in its economic masterplan to raise the city's GDP from $140 billion to $300 billion by 2030 underscores the potential for economic growth hubs across the country.

Capital Expenditure and Growth Impact:

Capital spending plays a pivotal role in driving medium-to-long-term economic growth. Research studies have demonstrated the multiplier effect of capital expenditure, with every rupee spent by the Centre having a multiplier effect of 3.25 on output, and every rupee spent by states resulting in a two-rupee increase in output.

During 2021-22 and 2022-23 (BE), there was a significant increase in capital expenditure, leading to a lower revenue expenditure to capital outlay (RECO) ratio for states, reaching a multi-year low in 2022-23. Recognizing the potential for growth through capital expenditure, the government introduced the 'Special Assistance to States for Capital Investment' scheme in the Union Budget 2023-24. A similar scheme had been executed in the previous financial year, with approved capital investment proposals of Rs. 95,147.19 crore.

Furthermore, data from the Comptroller and Auditor General (CAG) revealed that the combined revenue deficit for 24 states in 2022-23 was substantially lower than budget estimates, primarily due to better-than-expected revenue balances reported by several states, including Karnataka, Maharashtra, Gujarat, Kerala, and Tamil Nadu. These states also witnessed all-time high capital expenditure.

Future Growth Prospects:

The collective efforts of Indian states to improve fiscal health, encourage investment, and increase capital expenditure have set the stage for a high-growth era. With the Union Government's commitment to boosting capital expenditure, the country is poised for substantial economic expansion.

India, already the third-largest economy in Purchasing Power Parity (PPP) terms, has made significant progress toward becoming the world's third-largest economy, as envisioned by the Prime Minister. The International Monetary Fund (IMF) predicts sustained growth of over 6% in the coming years, and the country is on track to achieve this ambitious goal.

A report by the State Bank of India (SBI) highlights the broad-based growth in credit across sectors, further indicating a positive economic outlook. The Union Government's increased budget allocation for capital expenditure and the continuation of the 'Special Assistance' scheme for states suggest that the growth trajectory is set to rise significantly.

Conclusion:

The fiscal health and investment activity of Indian states provide a promising outlook for the country's economic growth. Robust fiscal management, revenue augmentation measures, and a focus on capital expenditure have contributed to improved state finances. States actively promoting investment in emerging sectors and attracting FDI are pivotal to India's economic expansion. With the multiplier effect of capital expenditure and the Union Government's commitment to supporting states' growth, India is well-positioned to achieve its goal of becoming the third-largest economy in the world. The collaborative efforts of states and the central government, coupled with the resilience displayed during challenging times, reaffirm India's potential as a global economic powerhouse.