Fiscal Sustainability in India at State Level

By Makin, Anthony J.; Arora, Rashmi | Public Finance and Management, October 1, 2012 | Go to article overview

Fiscal Sustainability in India at State Level


Makin, Anthony J., Arora, Rashmi, Public Finance and Management


ABSTRACT

The consolidated measures of budget deficits and public debt levels for India's central and state governments are well above the average of other emerging economies. In contrast to previous studies of India's budgetary position, which focus on the central government's budget, this paper examines fiscal sustainability at the level of India's states, which differ widely in terms of their level of economic development. After comparing fiscal performance in the states, key formulae for examining public debt sustainability at the sub-national level in India are derived. These formulae are then applied, firstly to identify states where public debt has stabilized as a percent of Gross State Domestic Product, and secondly to gauge the size of the primary budget balances needed to achieve a 25% public debt to GSDP ratio within three, five and ten year horizons.

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

The size of fiscal deficits and sustainability of public debt levels remains a key macroeconomic policy issue in many industrial, developing and emerging economies following the global financial crisis of 2008-09. Amongst emerging economies, India has experienced one of the largest, most persistent, fiscal deficits at the national government level in the Asia-Pacific region, averaging over 6% of GDP over the period since the crisis. On a consolidated basis, In-dia's general government budget deficit, including off-budget liabilities and the budget deficits of India's state governments, has been significantly greater than the national government's budget deficit, having recently reached around 10% of GDP (Asian Development Bank 2010).

India's stock of general government debt a measure combining both na-tional and sub-national debt, presently stands at around 80% of its GDP, more than double the average public debt ratio of emerging economies worldwide (Lipsky 2011). Public debt levels of this order which have been generated by persistently large budget deficits over a lengthy period become unsustainable when the path of debt becomes unstable, triggered whenever the effective in-terest rate payable on the outstanding stock of public debt exceeds the rate of growth of an economy's output, as explained in greater depth subsequently. Policymakers need to avoid the public debt traps that eventuate under these conditions in order to prevent a collapse of investor confidence and ensuing financial crisis that escalating public debt can trigger.

Although the literature on India's fiscal performance has mostly focused on budget deficits and public debt sustainability at the national level, this pa-per will concentrate on these phenomena at sub-national level. India is an ex-cellent case study as it is a very large federation comprising 28 states and 7 union territories. The states are quite diverse in terms of natural resources, his-tory, culture, language, cuisine and levels of economic development. In this paper we examine the budgetary positions of the seventeen largest states ac-counting for over 90% of India's population.

Using Rostow's stages theory of economic growth, Arora (2009) has shown that some Indian states have not even developed the pre-conditions for take-off(stage 2), while others have reached advanced stages of take-offand drive into maturity, and are more similar to developed countries (Kochhar et al. 2006). Fiscal performance also varies widely across the states, leading to significant variation in their budget deficits and public debt levels (Rajaraman, Bhide, & Pattnaik, 2005). Consistent with increased decentralisation of public sector activities in developed and developing countries around the world, sub-national governments in India have assumed increased responsibility for government spending and revenue raising to meet growing infrastructure needs. Moreover, on the demographic front, while some states in India have fast growing young populations, others have ageing populations which affects social expenditure on education, health and pensions differently across state borders. …

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