RBI Highlights the Need for States’ Sustained Fiscal Prudence

Sub: Eco

Sec: Fiscal Policy

RBI’s Key Observations on State Finances:

Fiscal Deficit Management:
- States successfully contained Gross Fiscal Deficit (GFD) within 3% of GDP during 2022-23 and 2023-24.
- For 2024-25, GFD is budgeted at 3.2% of GDP.
Revenue Deficit:
- Revenue deficit was maintained at a low 0.2% of GDP for 2022-23 and 2023-24.
Capital Expenditure Improvement:
- Increased from 2.4% of GDP in 2021-22 to 2.8% in 2023-24.
- Budgeted to rise further to 3.1% of GDP in 2024-25.
Outstanding Liabilities:
- Declined from 31.0% of GDP (March 2021) to 28.5% (March 2024).
- However, liabilities remain higher than the pre-pandemic level (25.3% in March 2019).

Strengthened Fiscal Discipline:

Fiscal Responsibility Legislations (FRLs):
- State-specific FRLs and reforms in tax and expenditure contributed to stronger state finances over the past two decades.
Key Recommendations for Improvement:
- Adoption of a risk-based fiscal framework.
- Provisions for counter-cyclical fiscal policy actions.
- Establishment of a medium-term expenditure framework.
- Transparent and time-bound debt consolidation plans, including:
  - Reporting of outstanding liabilities.
  - Off-budget borrowings.
  - Guarantees.

Need for Sustained Fiscal Prudence:

High debt levels, contingent liabilities, and rising subsidies pose challenges to fiscal stability.
Emphasis on prioritizing growth-enhancing capital expenditure while maintaining fiscal discipline.

Counter-Cyclical Fiscal Policy

A counter-cyclical fiscal policy involves increasing government spending or reducing taxes during economic slowdowns to stimulate growth and reducing spending or increasing taxes during economic booms to control inflation and prevent overheating.
Purpose: To stabilize the economy by smoothing out fluctuations in the business cycle.

Off-Budget Borrowings

Off-budget borrowings are loans raised by public sector entities or special purpose vehicles on behalf of the government.
These borrowings are not directly reflected in the government’s budget or fiscal deficit figures, leading to reduced fiscal transparency.
Typically used to fund schemes or projects without formally increasing the fiscal deficit.

Gross Fiscal Deficit (GFD)

Gross Fiscal Deficit refers to the excess of the government’s total expenditure (including loans, grants, and interest payments) over its total revenue (excluding borrowings). It is a critical indicator of the financial health of the government and reflects its borrowing requirements.