Sub-national Fiscal Reforms and Debt Management - the Indian Experience* Shyamala Gopinath - RBI - Reserve Bank of India
Sub-national Fiscal Reforms and Debt Management - the Indian Experience* Shyamala Gopinath
Sub-national Fiscal Reforms and Debt Management – the Indian Experience* It gives me great pleasure to be here amongst you and address the World Bank Sub-national Fiscal Reform and Debt Management Forum. There is more than one reason on my part to accept this invitation, but more importantly, to share with you the turnaround story at the sub-national level in India. The relevance of fiscal reforms and creation of fiscal space even at the sub-national level can hardly be over-emphasised in the context of the on-going slowdown the world over. Indeed, contrary to the general perceptions, we find in India that even the sub-national authorities have important counter-cyclical role to play. Interestingly, the Reserve Bank of India as the debt manager of Governments – federal and provincial – has all through been closely associated with the task of putting in place a reformed fiscal architecture in the country. Let me now share with you the details, which run into eight sections, the first being the Constitutional position of the sub-national Governments. In the absence of firm data on local bodies (the third tier of government in India), the analysis is confined to the level of provincial governments. I. Constitutional Provisions and Debt Management The States’ ability to undertake and perform the developmental functions adequately and effectively is critically predicated on their fiscal position, which is a function of their own efforts in generating resources – tax, non-tax receipts and borrowings as also the resource transfer from the Central Government. Sub-National Borrowings Loans from Centre Special Securities issued to National Small Savings Fund (NSSF) Open Market Borrowings Debt Management in 1990s In 1997, State Governments were given the option to enter the market individually to raise resources using the tap method or the auction method. In 1999, States began to adopt the auction method and some States were able to mobilise loans at competitive rates, whereas other States had to pay higher rates. The spreads in tap tranches were subsequently raised to around 50 basis points in 2001-02 from 25 basis points earlier with the introduction of Umbrella Tap Tranche for a total targeted amount at a predetermined coupon. The tap used to be normally kept open for 1-3 days. With the deterioration in the State fisc and defaults in State guaranteed securities, the spread over secondary market yield of Central Government security increased steadily. The market seemed to have ceased to differentiate amongst States in terms of their fiscal performance. The share of market borrowings by auctions declined from 15.0 per cent during 2001-02 to 2.3 per cent in 2004-05 and the Reserve Bank had to play an active role in convincing some of the leading players to subscribe to State Government securities. II. Fiscal Decline of the States in Late 1980s III. Sub-National Fiscal Reforms (i) Tax Reforms (ii) Non-tax Measures (iii) Expenditure Management (iv) Public Sector Restructuring Several States have shown interest in undertaking a comprehensive review of the functioning of the State Public Sector Undertakings (SPSUs), including the possibility of closing down of non-viable units after providing for suitable safety-nets to the employees including VRS. States encouraged private sector participation in the transport and power generation sectors, set up the State Electricity Regulatory Commission (SERC) and pursued with unbundling or corporatisation of the SEBs. One of the major tasks entrusted to the SERC is to rationalise tariff rates. Further, the States have signed Memorandum of Understanding (MoU) with the Union Ministry of Power to undertake reforms in a time-bound manner. (v) Institutional Reforms Eleventh Finance Commission Twelfth Finance Commission Second, the TwFC recommended back-to-back transfer of external assistance to the States from the Centre with the States having to bear full exchange rate risk. Third, the TFC recommended a fiscal restructuring plan based on the enactment of fiscal responsibility legislation, inter alia, including (i) elimination of revenue deficit (RD) by 2008-09 and (ii) containment of gross fiscal deficit (GFD) to 3.0 per cent of GSDP. If the States are able to fulfil these requirements, they would be entitled to debt relief including debt write-off in respect of Central loans. Implementation of TwFC’s Recommendations Consolidated Sinking Fund Prepayment of Debt State Finance Commission The Constitution (73rd and 74th) amendment Acts, 1993 have respectively, accorded constitutional status to rural and urban local bodies as the third tier of Government. The Amendments provide for constitution of State Finance Commissions every five years. Following the recommendations of the State Finance Commissions (SFCs) and taking into account the devolutions made by the Central Finance Commission (CFC), the State Governments are required to devolve resources to their local bodies. Not all States have constituted SFCs. and a fewer States have submitted action taken reports (ATRs) on the recommendations made by the SFCs as noted by the Twelfth (Central) Finance Commission (TwFC). The TwFC, inter alia, recommended that SFCs should follow a normative approach in the assessment of revenues and expenditure in order to arrive at the gap that may be considered by the CFC and that the principal recommendations of the SFCs may be accepted without modification as in the case of CFC. V. Role of the Reserve Bank of India in Sub-National Finances Study of State Finances The Reserve Bank prepares and publishes an annual Study on the State Government Finances. This is a unique study since it compiles, consolidates and analyses detailed data on the budgets of all the State Governments. It also documents the policy initiatives on State finances and debt management by the State Governments, the Government of India and the Reserve Bank. The study has been well received by policy makers and academicians, both in India and abroad, and is an important reference document. Model Fiscal Responsibility Legislation The RBI played a facilitating role in the States’ endeavour for rule-based fiscal reforms by providing the Secretariat support to a group of State Finance Secretaries for preparing a model fiscal responsibility legislation for the States. The final report was submitted to the Reserve Bank in January 2005. The Group recommended that the model legislation would generally follow the pattern of the Central FRBM Act, and build upon the State fiscal responsibility legislations already enacted. The Group also took into account the international best practices available in the area as well as the recommendations of the various committees on fiscal transparency and on the issues related to voluntary disclosure of information by the State Governments. Various dimensions of the fiscal legislative framework, such as, the choice of targets, the road map, independent evaluation criteria, prioritisation of capital expenditure, treatment of contingent liabilities including guarantees and computation of pension liabilities were deliberated upon to arrive at a consensus. State Finance Secretaries Conference Clearly, the Reserve Bank has gone beyond its statutorily mandated obligations and has provided the platform for interface between the RBI and the State Governments based on mutual trust on issues related to State finances where the other stakeholders – including representatives from the Government of India, Comptroller and Auditor General and the Planning Commission - are also invited to participate in the Conference. There are occasions when fiscal experts, leading commercial bankers and representatives of credit rating agencies were also invited to participate and contribute to the specific issues on the agenda. Since 1997, 21 such conferences have been held and decisions have been arrived at, in a consensual manner, on many critical issues such as revisions in limits on Ways and Means advances and Overdraft Regulation Scheme, adoption of auction method for market borrowing, setting up of Consolidated Sinking Fund, ceiling on guarantees and establishment of Guarantee Redemption Fund, disclosure and transparency in budget-making, and model fiscal responsibility legislation at the State level. Standing Technical Committee on States’ Borrowings The Bank’s Annual Policy Statement for 2006-07 proposed to constitute a Standing Technical Committee (STC) under the aegis of the State Finance Secretaries Conference with representation from the Central and State Governments and the Reserve Bank to advise on the wide-ranging issues relating to the borrowing programmes of Central and State Governments through a consensual and cooperative approach. The STC was, accordingly, constituted in December 2006 with the concurrence of the Government of India and in consultation with States. All States, the Central Government and the Reserve Bank are members of the Committee. VI. State Government Guarantees and Fiscal Risk Management Against the imperative of infrastructural development on the one hand and resource constraint on the other, the States resorted to provision of guarantees mainly to third tier sub-national entities and State level public sector (but also private sector) bodies, to promote capital formation for economic development without regard to fiscal capacity for debt servicing in the event of devolvement of guarantees on State Governments. The Reserve Bank has sensitized the States about the fiscal risk associated with such guarantees, need for transparency with regard to the guarantee policies and the magnitude of guarantees. The Reserve Bank provided the forum in the form of State Finance Secretaries Conference where the issues related to guarantees were discussed. Further, the Reserve Bank provided the technical expertise and provided the Secretariat to the various Groups on State Guarantees. Pursuant to the recommendations of a Technical Committee, several States have since fixed a ceiling on guarantees to be issued by them. Further, a Group of State Finance Secretaries on the Fiscal Risk on State Government Guarantees (2002) underlined the importance of according appropriate risk weights in respect of devolvement of guarantees and suggested estimation of risk weighted guarantees so as to make adequate budgetary provisions for honouring these guarantees once they devolve on the States. Since 2003, the Reserve Bank has been also organising workshops on the evaluation of fiscal risks of guarantees for the benefit of State Government officials. The Report of the Fiscal Responsibility Legislation at the State Level (2005) recommended fixing a limit on annual incremental risk-weighted guarantees in relation to their GSDP/total revenue receipts. Many States have incorporated this recommendation in their FRL although this was not mandated by the TwFC for receiving debt relief. Consequent to the improvement of the fiscal position of States, the record of honouring of guarantees by the State Governments has significantly improved. Guarantee Redemption Fund The Reserve Bank, in its capacity as a regulator of banks and financial institutions, issued a circular in 2003 to the effect that they should exercise due diligence and proper appraisal to ensure project viability, irrespective of the provision of State Government guarantees. The Reserve Bank also circulated a draft scheme on Guarantee Redemption Fund (GRF) amongst the State Governments for voluntary adoption. As on March 31, 2009 the aggregate investments of the nine State Governments that have set up the GRF amounted to Rs.30.4 billion. VII. Debt Management in an Era of Fiscal Consolidation With the implementation of the TwFC’s recommendations, the year 2005-06 marked a watershed in the evolution of State finances and debt management. During 2005-06, 48.5 per cent of the market borrowings were raised through the auction route as compared with 2.3 per cent in 2004-05. The moderation in fiscal imbalances and enactment of fiscal responsibility legislation facilitated the smooth transition to the conduct of entire open market borrowings by the auction route since 2006-07 as proposed by the Reserve Bank in its Annual Policy Statement 2006-07. This was notwithstanding the sharp increase in the net market borrowings from 0.3 per cent of GDP in 2006-07 to 1.9 per cent of GDP in 2008-09. Reflecting the maturity profile of State Governments as also the timing of issuances, the weighted average cost of States’ borrowings was marginally higher than that of the cost of borrowings of the Centre. The spread over the Central Government Securities has declined from 34 basis points in 2004-05 to 16 basis points in 2008-09 (Table). Table: Weighted Average Rate of Coupon on Market Borrowings
The interest rates on market borrowings continued to remain lower than 9.5 per cent charged for borrowings from the NSSF. The shift in borrowings from the NSSF and from the Centre to market borrowings has reduced the weighted average cost of borrowings of State Governments and at the same time, improved their maneuverability on the desired quantum of borrowings. Special Reserve Fund VIII. Ways and Means Advances to the State Governments The Reserve Bank of India (RBI) has been extending Ways and Means Advances (WMA) to the State Governments since 1937, under the provisions of Section 17(5) of the Reserve Bank of India Act, with the objective of covering temporary mismatches in cash flows of their receipts and payments. According to the Act, such advances are repayable not later than three months from the date of making that advance. The maximum amount of such advance by the RBI and the interest charged thereon are, however, not specified in the RBI Act but are regulated by voluntary agreements with the State Governments. At present, RBI is the banker for 26 States (i.e. barring Jammu & Kashmir and Sikkim) and the Union Territory of Puducherry. There are two types of WMA viz., (i) Normal or clean advances, which were introduced in 1937; and (ii) Special or secured advances, instituted in 1953, and which are provided against the collateral of Government of India securities. State-wise limits in respect of Normal and Special WMA are fixed based on certain parameters; these limits have been revised periodically over the years. An overdraft (OD) occurs whenever these limits are exceeded. Maximum time-period (days) and/or financial limits for which State Governments can remain in OD have been specified; these limits have also been revised periodically. Payments are suspended on behalf of the State Governments in case OD limits are breached. In view of the significant improvement in the cash position of the State Governments, the normal WMA limits which were raised periodically – usually on an annual basis – have been retained at the level prevailing since 2006-07. The WMA limits for 26 States and the Union Territory of Puducherry stand at Rs.9,925 crore. IX. Global Financial Crisis and the Way Forward Fiscal Outturn The consolidated fiscal position of the State Governments witnessed significant improvement in the recent yearsreflecting the higher share in Central transfers as a follow-up of the recommendations of the TwFC, States’ own efforts at revenue augmentation, rationalisation of revenue expenditure and the cyclical upturn in the global economy that had a ripple effect on State finances. States recorded a revenue surplus of 0.6 per cent in 2006-07 for the first time since 1986-87. For the fiscal 2008-09, 25 States presented a revenue surplus budget. Seventeen States budgeted their GFD at less than 3 per cent of GSDP. The outstanding liabilities of States declined from the peak of 33.2 per cent in 2003-04 to 28.3 per cent in 2007-08 (RE) and were budgeted to decline further to 27.4 per cent in 2008-09 (BE). With the decline in the outstanding liabilities, the ratio of interest payments to revenue receipts was estimated to decline to 15.1 per cent in 2008-09 from a peak of 26.0 per cent in 2003-04. The States have thus achieved the targets of fiscal deficit and debt/GDP ratio at the aggregate ahead of the schedule recommended by the 12th Finance Commission. Faced with the global financial crisis, the States were thus on a relatively firm ground having left with some fiscal space and accordingly given additional allocation of open market borrowings equivalent to 0.5 percentage point of a State’s GSDP as a part of the second fiscal stimulus package over and above the mandated 3.0 per cent during 2008-09. Impact on States’ Borrowings During 2008-09, the increase in net market borrowings of States has met with some investor fatigue reflecting the bunching of borrowings by States during the second half and the additional market borrowings by the Centre (Rs.1,16,000 crore or 2.1 per cent of GDP) over and above the budgeted amount. The spread increased to 102-236 basis points in auctions conducted during January 13, 2009 to March 24, 2009 from 30-98 basis points during the first half of 2008-09. Notwithstanding the increase in the spread, the cut-off yields ruled low at 6.65-8.89 per cent during January-March 2009 as compared with 8.39-9.90 per cent during the first half of 2008-09 in view of the reduction of the monetary policy rates, decline in inflation and flight to safety by investors. Impact on States’ Receipts and Way Forward The spill-over impact of on-going global financial crisis on State finances can be gauged from the revised estimates (RE) of 2008-09 as available in respect of 19 States in their budgets for 2009-10. A moderate growth in revenue receipts outstripped by a higher growth in revenue expenditure resulted in moderation in revenue surplus. There has been a decline in States’ own tax revenue and share in central taxes during 2008-09 (RE) over the budget estimates (BE). Despite this, consolidated revenue receipts in the RE have shown some improvement over the BE mainly on account of increase in States’ own non-tax revenues and grants from the Centre. During 2009-10 at the consolidated level, States are expecting some recovery on account of States’ own tax revenue as well as in share in central taxes. However, States’ own non-tax revenue is budgeted to decline during 2009-10. As per the RE, aggregate expenditure of States for 2008-09 increased by 5.7 per cent over the BE largely on account of increase in capital outlay. However, during 2009-10, while revenue expenditure is budgeted to increase by 12 per cent, capital outlay is budgeted to decline by 6.6 per cent. As a result, total expenditure of States is budgeted to increase by 9.6 per cent. Consolidated revenue surplus of 19 States as percentage of GDP has shown moderation in the RE of 2008-09, while it is budgeted to be wiped out and turn into deficit during 2009-10. The moderation in revenue surplus coupled with a decline in non-debt capital receipts and increase in capital outlay led to deterioration in gross fiscal deficit (GFD) in the revised estimates of 2008-09. In fact, to address the issue of slowdown, Central Government allowed the States to increase the limit of fiscal deficit to 3.5 per cent during 2008-09. Thus, States were allowed to raise the additional market borrowing to the extent of 0.5 per cent of GSDP. This additional fiscal space was to be utilized for making capital investment. In addition, some States have also introduced stimulus packages to boost investment particularly in infrastructure sectors. GFD as a percentage to GDP is budgeted to increase further during 2009-10. We expect that once the global economy begins to recover, the sub-national governments would re-affirm their commitment to the fiscal responsibility and be back onto the path of fiscal consolidation. Meanwhile, the challenge for the governments and the RBI is to manage the transition with as little pain as possible. * Paper presented at the workshop on ‘Sub-national Fiscal Reform and Debt Management’, April 29, 2009, Washington, organised by the Economic Policy and Debt Department, World Bank. Assistance provided by Sanjay Hansda and Arghya Mitra in preparation of the paper is gratefully acknowledged. |