The fiscal tightrope for State govts., Pg10

Key Highlights:

• Indian states like Kerala and Tamil Nadu, despite social and economic advancement, face significant fiscal stress due to high outstanding debt.
• This debt often stems from a mismatch between ambitious development aspirations and the limited fiscal capacity of state governments.
• States bear a larger share of overall government spending, particularly on crucial social and economic sectors, while the power to raise taxes primarily rests with the Union government.
• Kerala's capital expenditure is only 10% of its budget, with substantial portions allocated to salaries (20%), pensions (15.3%), and interest payments (16.5%).
• The cost of borrowing for Indian states through State Development Loans (SDLs) is significantly higher (6.5% to 7.5%) compared to the Union government and Chinese local governments.
• Kerala exhibits a low credit to deposit ratio of 66%, indicating unutilized domestic savings that could potentially be channeled into investments.

Fiscal Tightrope.png

Detailed Insights:

• State government debt accumulates over years due to persistent deficits, where expenditure exceeds tax and other receipts.
• Per capita social expenditure in Kerala and Tamil Nadu (30% and 20% higher, respectively) significantly surpasses the average for all Indian states (2020-23 data).
• States primarily fund expenditures through their own revenues, such as State Goods and Services Tax (SGST) and sales tax, supplemented by fiscal transfers, grants, and loans from the Union government.
• Kerala's share in the Union government's tax devolution (1.92%) is lower than its population share (2.6%) in 2023–24.
• The fiscal dilemma for states like Kerala involves balancing essential social sector spending with the urgent need for large-scale investments in infrastructure, higher education, and public transport.
• A low credit to deposit ratio suggests that banks are not lending out a large proportion of their deposits, indicating a potential for greater credit deployment to stimulate economic activity.
• In contrast, China's local governments heavily finance investments through borrowing, utilizing domestic savings via Local Government Bonds (LGBs), land sales, and Local Government Financing Vehicles (LGFVs).
• The high interest burden on state borrowings further exacerbates the debt situation, limiting funds available for developmental activities.
• Indian state and Union government bonds are largely purchased by domestic financial institutions, including commercial banks and insurance companies.

Key Concepts Involved:

• Fiscal Stress: A situation where government expenditure significantly exceeds revenue, leading to continuous borrowing and a large portion of revenue being used for debt repayment.
• State Development Loans (SDLs): Dated securities issued by state governments to meet their market borrowing requirements and fund their fiscal deficits.
• Fiscal Transfers: Mechanisms through which funds are transferred from the Union government to state governments, including tax devolution and grants-in-aid, to address vertical and horizontal fiscal imbalances.
• Credit to Deposit Ratio: A financial metric indicating the proportion of a bank's total deposits that has been extended as loans and advances.