RBI Urges States to Prioritise Subsidy Review For Better Fiscal Health

The fiscal year 2024 marked another milestone for India’s States in managing their finances effectively. By maintaining the gross fiscal deficit (GFD) at 2.9% of GDP, they not only adhered to the Fiscal Responsibility Legislation limit of 3% but also displayed resilience amidst economic pressures. However, challenges such as debt reduction, subsidy rationalisation, and reforms in critical sectors like power distribution continue to demand attention.

Fiscal Deficit and Expenditure Quality

States recorded a marginal increase in GFD from the previous year, staying within the permissible limit. A significant highlight was the improvement in expenditure quality, with capital outlay rising to 2.6% of GDP in FY24 from 2.2% in FY23. This reflects a growing focus on infrastructure and long-term investments over short-term revenue expenditure.

For FY25, States are budgeted to maintain fiscal discipline with the GFD expected at 3.2% of GDP, while continuing efforts to enhance the quality of expenditure.

Debt Levels: A Persistent Concern

At the end of March 2024, States successfully reduced their overall debt to 28.5% of GDP. While this is a positive step, it remains significantly above the recommended level of 20% by the Fiscal Responsibility and Budget Management Review Committee (2017). Bridging this gap is critical to ensuring long-term fiscal sustainability.

Key Challenges and Recommendations

1. Rationalisation of Centrally Sponsored Schemes:

The Reserve Bank of India (RBI) emphasised the need to rationalise the number of centrally sponsored schemes. This would enable States to reallocate resources toward productive sectors like health, education, agriculture, and rural infrastructure.

2. Subsidy Review:

An urgent reassessment of subsidy expenditures is necessary to free up funds for essential investments. Overdependence on subsidies diverts resources from developmental priorities, making reform in this area vital.

3. Next-Generation Fiscal Rules:

The RBI recommended adopting “next generation” fiscal rules, which balance medium-term sustainability with short-term flexibility. These rules would allow States to respond effectively to economic shocks while maintaining fiscal discipline.

4. Technological Integration in Tax Systems:

Leveraging data analytics, machine learning, and artificial intelligence can help States refine taxation systems, widen the tax base, and augment revenue generation capabilities.

Electricity Distribution: A Critical Drag

Electricity distribution companies (discoms) continue to weigh heavily on State finances, with accumulated losses reaching ₹6.5 lakh crore by FY23, equivalent to 2.4% of GDP. Structural reforms in this sector, such as tariff rationalisation, reducing transmission losses, and privatisation of distribution, are crucial for financial stability.

Strengthening Local Bodies

Timely appointment of State Finance Commissions and adherence to their recommendations are necessary to ensure adequate funding for local bodies. This would enhance the delivery of public services and support grassroots development.

Fiscal Transparency and Data Reforms

Improving fiscal transparency and disclosure practices remains a key priority. Strengthening fiscal data generation and dissemination processes can enhance accountability and enable informed policymaking.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.