RBI flags concerns over state sops even as tax revenue grows, spending quality improves

Mumbai: India’s banking regulator has flagged concerns about a slew of sops announced by several states, even as their tax revenue has grown faster than the economic growth rate after the pandemic year of FY21, and spending quality improved in favour of more productive asset creation.

“Several states have announced sops pertaining to farm loan waiver, free electricity to agriculture and households, free transport, allowances to unemployed youth and monetary assistance to women in their Budget for 2024-25,” the Reserve Bank of India (RBI) said in its study of budgets of 2024-25 released on Thursday.

“Such spending could crowd out the resources available with them and hamper their capacity to build critical social and economic infrastructure,” it said. A credible roadmap for states’ fiscal consolidation was needed, RBI said.

Meanwhile, the average buoyancy of states’ own tax revenue went up in the post-pandemic period of FY21-25 to 1.4 from the pre-pandemic average of 0.86 during FY13 to FY20, according to the report.

Improved tax buoyancy implies greater efficiency in tax collection, something that has helped states in allocating greater funds for building assets like highways, bridges and other facilities. Typically, buoyancy above 1% indicates faster revenue collection growth compared to nominal GDP growth.

Read more: Data dive: What the Centre's demand for additional funds tells us about the economy

The report also noted that states have earmarked ₹9.2 trillion as capital outlay in 2024-25, which accounts for 2.8% of gross domestic product (GDP) compared to ₹7.6 trillion in FY24, which accounts for 2.6% of GDP.

Even as capital expenditure is projected to increase this year, states are expected to maintain fiscal discipline with the gross fiscal deficit budgeted at 3.2% of GDP in 2024-25, a marginal increase from last year’s level, said the report.

States’ increasing capital expenditure is in line with Centre’s strategy of spending more on this sector as it stimulates economic growth. The central government has an effective capex of ₹15 lakh crore this year, including the grants given to states for investing in infrastructure.

RBI, however, highlighted that Arunachal Pradesh, Himachal Pradesh, Sikkim and Tripura have forecast high gross fiscal deficit in 2024-25, whereas large state economies like Gujarat and Maharashtra have budgeted lower fiscal deficit as a share of GDP. The central bank, therefore, asked state governments to have a clear, transparent and time-bound glide path for debt consolidation, given the high debt levels.

States’ revenue expenditure is projected to increase to ₹47.5 trillion in FY25, which accounts for 14.6% of GDP as against ₹ 39.9 trillion or 13.5% of GDP last year.

Subsidy burden

The report also noted the sharp rise in expenditure on subsidies, driven by farm loan waivers, free or subsidized services and cash transfers to farmers, youth and women are resulting in incipient stress.

"States need to contain and rationalise their subsidy outgo, so that such spending does not crowd out more productive expenditure," the report said.

States’ fiscal deficit is projected to touch ₹10.4 trillion in FY25, accounting for 3.2% of GDP, compared to ₹8.7 trillion accounting for 2.8% of GDP in the year before.

Read more: Highway capex moves in slow lane in FY25

According to RBI, rationalization of centrally sponsored schemes (CSS) can also free up budgetary space to meet state-specific expenditure needs and reduce the fiscal burden of both the Union and state governments.

State governments have demonstrated fiscal prudence by containing their consolidated gross fiscal deficit and revenue deficit, while continuing to improve the quality of expenditure. While states’ total outstanding liabilities have been declining, they remain above the pre-pandemic level, the report said.

Overall debt of states has remained the same at 28.5% of GDP at end of March 2024 compared to the previous year. It is, however, lower than 31% at end of March 2021.