Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
State governments face the heat as deficits rise - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Feb 22, 2000

    State governments face the heat as deficits rise

    The fact that finances of the state governments are in a dismal state often goes unnoticed. This is mainly due to the more pressing concern regarding central government finances. However, there is a need to look into the performance of the state governments with a view to improving the consolidated financial position of the Indian economy.

    A recent publication of the Reserve Bank of India (RBI) highlighted the key reasons for the rising deficits at the state level. Before that let's take a look at the performance of the state government finances over recent years.

    as % of GDP (market price)

    One of the key reasons for the deterioration in the finances of the state governments was the slower growth in the revenue receipts of the state governments. Infact, total revenue mobilisation was 7% lower as compared to the budgeted amount for the year. The contributing factors to this were:

    • Decline in devolution of income taxes and excise duties from the centre. This was mainly due to the economic slowdown, which resulted in a lower pool of tax and excise collections. Consequently the states' shares were lower than anticipated (12.5% lower than budgeted).
    • State governments have resorted to competitive reductions in sales tax to attract investment in their respective states. This has resulted in the erosion of revenues from this key source (60% of state tax revenues). Infact sales tax collections were lower by 6% as compared to budgeted figures.
    • Finally, the economic slowdown also hurt the states' revenue generation from the levy of taxes on vehicles, commodities and goods among others.

    However, it must be mentioned that capital receipts were 20% higher than budgeted for. This was mainly due to higher market borrowings and loans and advances from the centre.

    The decline in revenues is only one side of the coin. The sharp deterioration in the finances of the state governments can also be attributed to the rise in expenditures. While developmental expenditure (including education and rural development among others) was higher by 7%, non-developmental expenditure (including interest expenditure and administrative expenses among others) was actually lower by 10% as compared to budgeted figures. Overall, expenditure was higher by 1.6%, mainly due to higher capital expenditure.

    The expenditure side of the finances brings an interesting view to light. While the governments have been able to contain revenue expenditure at budgeted levels (despite rise in pay levels and interest expenditure), the rise in capital expenditure has overshot the target. Although this should be acceptable (subject to the size of the deficit) as there will be a future stream of earnings from such expenditure, it highlights the rigidity of the revenues of the state governments. Or looked at from another point of view, according to the RBI, this brings to light the important issue of 'integrity of budgeting'. This refers to the level of accuracy of the budgeted figures vis a vis the actual outcome.

    The result of the decline in revenues and the rise in expenditure is evident from the sharp rise in the deficits at the state level (see table).

    There is a pressing need for the state governments and the centre to try and correct the deficits at the state level. The main objective should be to plug the revenue deficit. In the medium to long term efforts should be made to eradicate the primary deficit (gross fiscal deficit less expenditure on interest payments). In other words, the situation should be improved to such a level that the state governments do not have to borrow to pay interest on outstanding debt.

    The RBI mentions four main heads under which efforts are being initiated to curb deficits:

    1. Revenue mobilisation
    2. Expenditure management
    3. PSU reform
    4. Infrastructure development

    On the revenue front, the central and state governments have already agreed on a uniform sales tax to curb the practice of competitive reduction. Further to this measures have been initiated to do away with sales tax based incentives for attracting investment. Harmonisation of taxes across various states will go a long way in improving the tax revenue collections of various states.

    The non-tax revenues of the state governments also need to be lifted. Non tax revenues are primarily derived from state public sector undertakings like State Electricity Boards. However, instead of contributing to the resources, the public sector units more often than not are cost centres. The decision to invite private sector participation in public sector units is a welcome step as it would generate resources (for the state) and go a long way in improving the efficiency and productivity of these undertakings.

    The most crucial issue relates to expenditure management. It is generally accepted that capital expenditure should not be sacrificed at the altar of fiscal deficit. The rational goes that capital expenditure increases the income generating capacity of an economy and therefore plays a key role in improving the standards of living over a period of time. However, in India the existing standards of living are very low and a large chunk of the population does not have access to even the basic amenities of life. In this context it is essential that developmental expenditure on social services like education and welfare should be liberal. The state governments would therefore have to walk the tight rope while allocating resources.

    There is an urgent need to raise revenue and cut expenditure. However, while the former is largely dependent on the devolution of taxes and grants from the centre, the latter is increasingly becoming sticky. As a result the state governments have little control over their finances. Recent developments highlight the determination, both at the central and state level, to correct this mismatch in state level resources. It is unlikely that these measures will show results in the short term. Nevertheless, given their long term potential, they must be pursued with zeal and vigour.



    Equitymaster requests your view! Post a comment on "State governments face the heat as deficits rise". Click here!


    More Views on News

    Insider Leaks Equitymaster Stock Picks (The 5 Minute Wrapup)

    Jul 25, 2017

    Equitymaster HQ has been infiltrated. Valuable stock ideas have been leaked. Who's responsible?

    Raymond and Other 'For Profit' Companies Who Don't Care about Shareholder Returns (The 5 Minute Wrapup)

    May 27, 2017

    What happens when minority shareholders are short-changed in the normal course of business?

    Why Commission Driven Model In Mutual Funds Should Be Eliminated... (Outside View)

    Feb 15, 2017

    PersonalFN believes SEBI has taken a step back-apparently in the admission of it going overboard with the regulations.

    This Book Changed How I Looked at the World of Man and Money (Vivek Kaul's Diary)

    Aug 24, 2016

    And here's your chance to claim a free copy of this book...

    The Developed World is Dying because of Demographics, Debt, and Deflation (Vivek Kaul's Diary)

    Aug 12, 2016

    And Why India's demographic dividend could turn out to be a doubtful debt...

    More Views on News

    Most Popular

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    The Most Important Innovation in Finance Since Gold Coins(Vivek Kaul's Diary)

    Aug 10, 2017

    Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    Bitcoin Continues Stellar Rise(Chart Of The Day)

    Aug 10, 2017

    Bitcoin hits an all-time high, is there more upside left?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms