Chapter I	Introduction
Chapter II	Reserve Bank Accommodation to the State Governments: Evolution and Current Arrangements
Chapter III	Post 1999 Experience : An Assessment
Chapter IV	Conclusions and Recommendations
Annexes

Chapter I

Introduction

1. The present system of Ways and Means Advances (WMA) extended by the Reserve Bank of India (RBI) to the State Governments is based on the principles contained in the recommendations of the Informal Advisory Committee (IAC) (Chairman: Shri B.P.R. Vithal, Member, Tenth Finance Commission; Member: Dr. Ashok Lahiri, Director, National Institute of Public Finance and Policy; and Member-Secretary: Smt. Usha Thorat, Chief General Manager, Internal Debt Management Cell, RBI) set up in 1998. The IAC had recommended substantial enhancement of limits of WMA but had stated that these limits should remain unchanged for the period covered by the recommendations of the Eleventh Finance Commission. However, based on the representations from the State Governments, an Informal Group of State Finance Secretaries (GFS) was constituted by the RBI in November 2000. Certain modifications in the existing scheme and further enhancements of WMA limits were recommended by this Group. While accepting them, the RBI decided to review the entire formula of WMA in the light of the emerging conditions in State finances, two years after adopting the recommendations of the GFS, to take effect from April 1, 2003. Accordingly, an Advisory Committee was constituted to review the existing WMA Scheme to the State Government under the Chairmanship of Shri C. Ramachandran, former Secretary (Expenditure), Government of India and former Executive Director, Asian Development Bank with Shri Suman Bery, Director-General, National Council for Applied Economic Research (NCAER) as Member and Shri H.R. Khan, Chief General Manager, Internal Debt Management Cell (IDMC), RBI as the Member-Secretary. Dr. Charan Singh, Director, IDMC was the resource person.

2. The terms of reference of the Committee were as follows:

1. to examine the existing scheme of WMA of the State Governments;
2. to consider rationalisation, if warranted, revision of limits, keeping in view the needs of State Governments as also the issues relating to fiscal and monetary management;
3. to examine the overdraft regulation scheme for the State Governments;
4. to examine the scheme of Special WMA of the State Governments; and
5. to examine other aspects related to cash management of the State Governments as may be deemed necessary with particular reference to their transactions with RBI including the scope for refinement in the existing system and procedure.

The Committee held its first meeting at RBI, New Delhi on October 7, 2002 at which the existing structure of the WMA scheme was discussed. The Committee also held discussions on the current economic situation in the country, the deteriorating fiscal conditions of the States, the nature of the banking facilities extended by the RBI to the State Governments and the problem of assessing the periodicity and the exact magnitude of the mismatches between receipts and expenditure of the State Governments.

3. The Committee met the Finance Secretaries of the State Governments, officials of Government of India (Ministry of Finance), Planning Commission and the Twelfth Finance Commission, RBI and other experts. The schedule of these meetings is set out in Annexe-I.I. The views of the State Finance Secretaries were not only elicited in the meetings (Annexe-I.II) but were also collected through a detailed questionnaire. The questionnaire along with the summary of the responses received from the State Governments are enclosed as Annexe-I.III. Further, in continuation of the discussions, specific views were gathered from six States (two special category and four non-special category States – Assam, Himachal Pradesh, Karnataka, Madhya Pradesh, Uttar Pradesh and West Bengal), as case studies (Annexe-I.IV). The list of officials and experts with whom the Committee interacted is furnished in Annexe-I.V. Special presentations to the Committee were also made by Karnataka and Tamil Nadu. The Committee would like to sincerely thank all the officials/experts and record its appreciation for the valuable inputs it has received from them in its deliberations.

4. The current report has four chapters including this introduction. In Chapter II the evolution and the current arrangements of RBI accommodation to the State Governments are discussed. This is followed by Chapter III which provides an assessment of the post-1999 experience. The conclusions and recommendations of the Committee are presented in Chapter IV.

Chapter II

Reserve Bank Accommodation to the State Governments:
Evolution and Current Arrangements

Background

1. The Ways and Means Advances (WMA) provided by the Reserve Bank of India to the States are governed by Section 17(5) of the Reserve Bank of India Act, 1934. This section authorises the RBI to extend WMA to the State Governments which are repayable not later than three months from the date of making the advances. Thus, these advances are meant to be temporary in character and are to be used to bridge any gaps that might arise for short periods between the expenditure and receipts of State Governments. They are intended to provide a cushion to the States to carry on their essential activities despite mismatches on fiscal transactions and to avoid disruptions to the normal and necessary financial operations of the State. There are no statutory provisions regarding the maximum amount of the advance or the rate of interest to be charged on WMA. These matters are regulated by the respective agreements which the RBI, as their banker, has with the State Governments. At present all the State Governments except Jammu and Kashmir and Sikkim have signed such agreements with RBI.

2. The RBI provides accommodation to the State Governments through two facilities. These are: (a) Normal WMA facility and (b) Special WMA facility which is secured against Government of India securities held by the State Governments with RBI. These facilities have been in existence since 1937 and 1953 respectively. The limits for WMA were set as multiples of the minimum balance held by the States with RBI as their banker. If the drawal of the funds by the State Governments exceeded these limits, they were deemed to have entered into Overdraft (OD). RBI in consultation with the Government of India has worked out regulations for restricting such OD. In a period of natural calamity or disaster, ad hoc WMA limits have been granted to the States to facilitate transactions in government accounts.

Normal WMA

3. The historical evolution of the Normal WMA facility is presented in Annexe-II.I. Normal WMA limits were earlier related to the minimum balances held by each State. A major change in the principles adopted for working out the WMA limits occurred in 1999 consequent to the recommendations made by the Informal Advisory Committee (IAC) on WMA to State Governments referred to in Chapter I. The IAC recommended delinking the practice of relating the size of the Normal WMA limit to the minimum balance held by the States and instead proposed linking it to the budgetary turnover of the State. This was justified on the ground that the size of the liquidity mismatch would be a function of the size of the budgetary transactions. In linking the WMA limits to the level of budgetary operations of the State, the IAC further advocated uniformity with regard to all States. In reckoning the level of budgetary operations, the IAC excluded revenue deficit of the States as the States are expected to operate within their available resources. It also concluded that it is difficult to measure with exactitude the size of mismatches that could arise in the financial transactions of the State. The IAC instead felt that it would be preferable to provide an adequate space by way of reasonably large WMA that could take care of all likely liquidity crunches that can occur in the cash flow of the States. These recommendations were accepted by the RBI. With effect from March 1, 1999, the overall WMA limit for the States was increased by 65% to Rs.3685 crore from Rs.2234.40 crore.

4. These increased limits were arrived at by applying a certain ratio to the base consisting of three years’ average of revenue receipts and capital expenditure of the States (1994-95 to 1996-97). The IAC consciously decided not to link the limits to the total expenditure (which is the logical surrogate for cash flows) as it would create an incentive for larger and more imprudent expenditure. Instead the IAC adopted revenue receipts as a proxy for the total expenditure minus the revenue deficit and included capital expenditure in the base as it believed that this should be normally matched by the capital receipts or revenue surplus. The ratio adopted by the IAC was 2.25 per cent for the non-special category States and 2.75 per cent for the special category States.

5. Despite the steep increase in limits as allocated by IAC, there were requests from several State Governments for further liberalization of these limits. The issue was discussed in the meeting of the State Finance Secretaries held on November 3-4, 2000 and an Informal Group of State Finance Secretaries (GFS) was constituted which submitted its Report to RBI in January 2001. On the basis of the recommendations of the GFS, the ratio was revised to 2.40 per cent for the non-special category States and 2.90 per cent for the special category States, i.e., a uniform increase of 0.15 per cent for both the categories of States. For the reorganized States, interim limits were fixed on their bifurcation in November 2000. Accordingly, the total revised normal WMA limits worked out to Rs.5,283 crore (based on revenue receipts and capital expenditure of 1997-98 to 1999-2000) as against the then existing limits of Rs.3,941 crore, an increase of 34 per cent with effect from February 1, 2001. As recommended by GFS, the limits were revised again in April 2002 to Rs.6,035 crore based on the latest three years’ average of revenue receipts and capital expenditure (1998-99 to 2000-01). The position of WMA limits since February 1999 till date is furnished in Table 1.

Table 1: Ways and Means Advances Limits of the State Governments

(Rs. crore)

Sr.No.	State	WMA -February 1999 (Pre-IAC)	WMA March 1999 - based on IAC recommen-dations	WMA February 2001 - based on GFS	WMA - April 2002	% Change (Col. 6 over Col. 3)
1	2	3	4	5	6	7
	Non-Special Category States
1	Andhra Pradesh	168.0	288	463	520	209.5
2	Bihar	117.6	195*	220	245	108.3
3	Chhattisgarh	-	82*	91	100	-
4	Goa	16.8	24	25	50	197.6
5	Gujarat	117.6	243	393	445	278.4
6	Jharkhand	-	51*	57	75	-
7	Haryana	50.4	99	167	180	257.1
8	Karnataka	134.4	228	331	375	179.0
9	Kerala	100.8	144	215	225	123.2
10	Madhya Pradesh	134.4	221*	244	275	104.6
11	Maharashtra	252.0	483	685	760	201.6
12	Orissa	100.8	141	159	185	83.5
13	Punjab	100.8	141	200	235	133.1
14	Rajasthan	100.8	202	288	310	207.5
15	Tamil Nadu	184.8	281	402	415	124.6
16	Uttar Pradesh	285.6	531*	559	630	120.6
17	West Bengal	168.0	235	295	360	114.3
	Total	2032.8	3589 (76.6)	4794 (33.6)	5385 (12.3)
	Special Category States
1	Arunachal Pradesh	16.8	28	35	50	197.6
2	Assam	67.2	114	161	180	167.9
3	Himachal Pradesh	33.6	59	92	115	242.3
4	Manipur	16.8	25	38	50	197.6
5	Meghalaya	16.8	25	30	50	197.6
6	Mizoram	16.8	25	28	50	197.6
7	Nagaland	16.8	26	40	50	197.6
8	Tripura	16.8	31	46	55	227.4
9	Uttaranchal	-	19*	19	50	-
	Total	201.6	352 (74.6)	489 (38.9)	650 (32.9)
	Total for all States	2234.4	3941** (76.4)	5283 (34.1)	6035 (14.2)

Figures in brackets are percentage variation over the previous period.
* Limits fixed in November 2000. The earlier limits in respect of Bihar, Madhya Pradesh and Uttar Pradesh were Rs.189 crore, Rs.232 crore and Rs.422 crore, respectively.
** The aggregate amount of WMA limits introduced in March 1999 was Rs.3,685 crore following the recommendations of IAC. In view of the formation of new States, limits were fixed in November 2000 for the six re-organised States.

Special WMA

6. The scheme of Special or secured WMA, which is granted against the collateral of Central Government dated securities and Treasury Bills held by the State Governments with RBI, was first introduced on April 1, 1953 when a uniform limit of Rupees two crore was allocated to each State. The sanctioned limits of Special WMA linked to the minimum balance had been revised upwards from 1967 to 1999. A brief historical review of special WMA is given in Annexe-II.II.

7. The scheme had not been effectively used by the State Governments since its inception as the operative limits were lower than their sanctioned limits in the absence of sufficient collaterals held by the States. However, the IAC was of the view that a scheme which encouraged the States to build up reserves in the shape of Central Government securities should not be discontinued. The IAC, therefore, recommended that the Special WMA should also be delinked from minimum balances and that States be allowed to draw Special WMA freely against their holdings of Government of India securities. Since 1999, the limits are directly proportional to the State Governments' holdings of Government of India dated securities and Treasury Bills without any ceiling. Accordingly the State Governments are being allowed Special WMA to the extent of around 85 to 90 per cent of the market value of their holdings of such securities after providing for margins against price risk, with a higher margin for securities of residual maturity in excess of 10 years.

Overdraft Regulation Scheme

8. In the first few decades following the inception of the arrangements for WMA in 1937, when the Bank entered into agreements with the Provincial Governments, the occasions of drawals beyond the WMA limits were few and generally for small amounts. However, a few States began running up large OD in their accounts with the Bank from the mid-sixties and needed periodic bailouts from the Central Government to help them clear such OD. The historical details of the OD and evolution of the institutional framework of the OD Regulation Scheme in 1985 are furnished in Annexe-II.III.

9. In October 1985, the Central Government advised the States that they should not be in OD with the RBI and if OD occurred and persisted beyond seven continuous working days, RBI would stop payments on that government’s account. The limit on number of days was extended to 10 consecutive working days in 1993. The IAC observed in 1998 that the scheme was working well as a disciplinary mechanism and, therefore, did not recommend any relaxation. It, however, found that some States which were persistently in OD were defeating the purpose of the scheme by adjusting their finances in such a manner that they would clear the overdrafts within the time limit only to emerge into OD subsequently. Recognising this, in addition to the existing limit of 10 consecutive working days that a State could be in OD, the IAC recommended a ceiling on the amount of OD, i.e., up to 100 per cent of Normal WMA limit and also a restriction on the number of days that a State could be in OD, i.e., 20 working days during any quarter in the financial year. In response to requests from the States, RBI deferred the implementation of the recommendation restricting the OD to 20 working days but accepted the imposition of a ceiling on the OD amount at 100 per cent of the Normal WMA limit with the provision that any OD over 100 per cent of the Normal WMA limit had to be cleared within three working days.

10. Subsequently in 2001, based on the recommendations of the GFS, the limit of 10 consecutive working days was extended to 12 consecutive working days and the restriction for bringing down the OD level within the level of 100 per cent of the Normal WMA limit was relaxed to five consecutive working days. Implementation of the norm to restrict the duration of the OD to 20 working days in a quarter continues to be deferred.

Minimum Balances

11. In terms of the agreement between the State Governments and the RBI, latter is required to transact the general banking business of the States for which State Governments have to keep a specified minimum balance with RBI. Under the agreements, the States were required to meet any temporary deficits in their minimum balances either by using their own Treasury Bills or by obtaining WMA from the RBI. The minimum balances were fixed for the first time in April 1937 but became effective from April 1, 1938. These amounted to Rs.195 lakh. The minimum balances have been revised upwards four times since then - April 1953 (Rs.4.00 crore), March 1967 (6.25 crore), May 1976 (Rs.13.00 crore) and April 1999 (Rs.41.04 crore). In 1999, based on the recommendations of IAC, RBI delinked the limits on WMA from minimum balance but revised and linked the minimum balances to the same base as Normal WMA. The minimum balances continue to be at Rs.41.04 crore since April 1999.

Interest Rates

12. Prior to May 1976, the interest rate on WMA did not exceed the Bank Rate. Thereafter the rate of interest on these advances was revised. From May 1976 to August 1996 a graduated scale of charges based on the duration of the advance was introduced to discourage the States from using the facility as a normal budgetary resource. Since then a single rate of interest is being applied on WMA. Till April 1976, interest on OD was being charged at the Bank Rate. From May 1976 to August 1996, the interest on OD upto a period of seven days was being charged at the Bank Rate and thereafter at three per cent above the Bank Rate. The changes made by the RBI in the interest rate structure relating to WMA and OD over the period are placed in Annexe-II.IV. At present, the rate of interest on WMA – both normal and special- is the Bank Rate and on OD, Bank Rate plus two per cent.

Central Government Scheme of WMA for State Governments

13. The Central Government also has a limited scheme of WMA facility to the State Governments. Such advances are generally provided for a duration longer than three months but have to be cleared on intra-year basis by March 31^st of every year. At present, the rate of interest on WMA of the Centre is 8 per cent per annum.

Chapter III

Post 1999 Experience : An Assessment

Introduction

As noted in the previous chapter, the WMA facility for State Government is derived from Section 17(5) of the Reserve Bank of India Act, 1934. Under this section, the RBI is authorized to make to the Central Government and the State Governments "advances repayable in each case not later than three months from the date of the making of the advance". WMA was thus, envisaged as a mechanism to help the States to tide over short-term mismatches between receipts and expenditure. It has, however, over a period of time assumed, in the case of many States, the form of a long-term financing facility.

2. In 1998, the Informal Advisory Committee (IAC) observed that the WMA / OD was no longer serving purely as a facility to meet temporary mismatches and short-term liquidity problems. Certain observations of the IAC in this regard remain relevant .They reveal how stress in liquidity management is rooted in structural imbalances in the States’ finances. The IAC had then stated –

"When a State remains in overdraft for such long periods as 200 days in a year, WMA becomes a resource and the overdraft becomes the WMA. The only difference is that the constraint is no longer a financial limit but a time limit. The peak level is no longer determined as a financial limit that can be brought down within the WMA limit within ten consecutive working days. The WMA, which was expected to be the safety net to bridge the gulf between the timing of receipts and payments, becomes the safety net between two spells of overdrafts. The crux of the matter is, therefore, not WMA, but the elimination of overdrafts. With the progressive deterioration in the fiscal balances of States over the years, there is a concern that the WMA limit, which is to meet temporary liquidity mismatches, is being used as a resource. This problem gets exacerbated by the growing differences between the Budget Estimates, Revised Estimates and Accounts in the Budget."

Utilisation of limits

3. In the existing system of WMA and OD, there is no requirement to liquidate the WMA/OD at the end of the financial year. This, as IAC had observed, "encouraged some States to use WMA and OD as a resource and has also led to difficulties in distinguishing between a temporary mismatch between cash receipts and cash expenditure and a manifestation of the underlying structural deficit". IAC underscored the danger of utilizing WMA as an additional financial resource for meeting the budgetary requirements by its observation that "it is important to recognize that enhancing of WMA limits increases the potential for their utilization". However, it did not want to provide any scope for complaint on the part of the States that the WMA limit was inadequate for normal mismatch problems. In view of the difficulty in calculating the exact cash flow mismatches that could occur intra-year for each State, the IAC opted for a liberal principle that a large enough limit on a common basis could be prescribed for all States which would provide abundant space within which "legitimate mismatches can reasonably be expected to be handled". Thus, in 1999 a major step-up in WMA limits was given to the States on the understanding that these limits would continue till the completion of the period of the 11^th Finance Commission. These limits got further enhanced in 2001 by the Informal Group of the State Finance Secretaries (GFS). As a result, the aggregate WMA limits which were Rs.2,234 crore in February 1999 rose to Rs.6,035 crore in April 2002, a substantial increase of 170%. Even if we consider the budgetary expenditure of State Governments in the aggregate (including all their deficits), there has been no matching growth of this order during this period. Notwithstanding the increase in limits, the strain on the WMA limits and the resort to OD by the States have increased rather than diminished (Annexe-III.I).

4. The number of States in WMA for more than 330 days in a year has increased from two in 1998-99 to five in 1999-2000, seven in 2000-01 and nine in 2001-02. In 2001-02, three States were in WMA for 365 days, one State for 364 days and two States for 359 days. In 2001-02, 18 States have used WMA for more than 200 days in a year compared to 15 States in 2000-01, 14 States in 1999-2000 and 11 States in 1998-99.

5. A similar trend has been observed in case of OD. In 2001-02 ten States have been in OD for more than 150 days as compared to seven States in 2000-01, four States in 1999-2000, and two States in 1998-99. On the other hand, six States have not emerged into OD in 2000-01 and 2001-02. They have also been using WMA sparingly. Besides two States have consistently been in OD for the most part of the year, i.e., for more than 300 days, four States have been in OD for more than 200 days in 2001-02. It is also observed that for a number of States the peak level of OD in 2001-02 has been substantially higher than the peak level reached in 2000-01. The peak levels of OD that the States have availed of are substantially higher than their WMA limits.

6. A large number of States increasingly prefer to use WMA in the range of 75 – 100 per cent of their limits and record OD within 100 per cent level of WMA limits. In the case of few States utilization of OD in excess of 100 per cent of the WMA limits has become a recurring phenomenon. The disaggregated analysis shows that some States encounter liquidity mismatch in the second and third week of the month. The utilisation of WMA/OD, therefore, increases during this period.

7. As noted by the IAC, such deterioration is a clear reflection of the worsening fiscal situation in many States and is directly contributing to a serious liquidity crunch and, worse still, in many cases forcing them to use a short-term facility on a long-term basis to meet the resource gap. The problem is compounded when such gap widens, rather than narrows, over a period consistently straining the WMA limits and the OD. All the Finance Secretaries with whom the Committee interacted agreed that the pressure on State finances results in frequent breaches of the WMA limits and the overstepping into OD is essentially because of the structural problems originating from the growing fiscal deficits of the States (Annexe-I.II). Many of them argued that the needed structural fiscal correction requires not only their own effort but also initiatives covering schemes of devolution from the Centre, interest burden and Plan funding. They contemplated an enhanced WMA facility as a stop-gap arrangement pending such widespread fiscal correction.

8. A few of the Finance Secretaries persisted with their argument that even in a hypothetically balanced budget situation, the intra-year/month liquidity mismatches would warrant a further enhancement of the WMA limit. However, the Committee is unable to find any justification or rationale for the argument that the existing WMA limits are inadequate to meet normal liquidity mismatches because of the following reasons -

1. Prior to March 1, 1999, when the limits for WMA for the States were substantially lower, there were fewer instances of the States continually overstepping these limits.
2. Thereafter, despite the increase in limits in 1999, 2001 and 2002, resort to full WMA limit for longer durations and spill-over into OD has increased in respect of many States contrary to the expectations. The increase in the WMA limits for the States have generally been greater than the increase in their revenue and capital expenditure between 1997-1998 and 2001-2002.
3. The problem of higher utilization of WMA limits and frequent resort to OD is not uniform for all States nor is it related to the size of their budgets as there are still a few States who sparingly use the facility of WMA or resort to OD.
4. The substantial rise in WMA limits provided by the IAC and enhanced thereafter provide adequate space to all States on a uniform basis for meeting the likely temporary cash flow mismatches.
5. An observation of the pattern of utilization in the last few years shows that there is no broad seasonality common to all States in the utilization of WMA/OD.

9. The demand for the enhancement of WMA and liberalization of the OD regulations arises because these are being viewed as a permanent source of finance for meeting the growing resource gap in the state budgets. The Committee observed that though the States might start with the hope that it would be a temporary bridging resource that could be paid off when additional resources are mobilized, the reality is that these expectations are rarely fulfilled for various reasons and the dependence on this facility gets prolonged. The availability of an enlarged facility encourages the States to undertake outlays and make expenditure commitments beyond the financial limit dictated by identified resources. Once such commitments are undertaken in the absence of a corresponding growth in other resources, a vicious cycle is created. It develops into a self-perpetuating dynamic cycle spurring incremental demand for funds in successive years from RBI as seen from the trend of utilization of WMA/OD.

Fiscal Situation of the States

10. The deteriorating fiscal condition of the States, as brought out by a number of indicators, indicates a close correlation between increased dependence on WMA/OD and fiscal stress of the States finances. The aggregate gross fiscal deficit (GFD) of the State Governments has risen steadily from 3.3 per cent of GDP in 1990-91 to 4.2 per cent in 2000-01 and 4.6 per cent in 2001-02 (Annexe-III.II). The analysis of decomposition of GFD reveals that the revenue deficit (RD) now accounts for more than half of the GFD as compared to 28.1 per cent in 1990-91 with the share of net lending and expenditure on capital outlay declining rapidly. In the financing of GFD, the shares of "others", which mainly includes negotiated loans and market borrowings, have increased from 33.3 per cent and 13.6 per cent in 1990-91 to 38.5 per cent and 15.1 per cent in 2001-02, respectively. The aggregate outstanding liabilities of the State Governments have also increased from 19.4 per cent of GDP at end-March 1991 to 25.6 per cent at end-March 2002.

11. A trend analysis of select fiscal indicators of the State Governments for the last five years reveals a continuous deterioration in the fiscal situation. Capital receipts are rising at a rate which is substantially higher than revenue receipts while the rate of growth in interest payments is higher than that of revenue and capital expenditure (Annexe-III.III). The interest burden on total liabilities of the State Governments as a percentage of revenue expenditure has increased from 9.5 per cent in 1990-91 to 19.46 per cent in 2001-02 and as a percentage of revenue receipts from 13.02 per cent to 23.81 per cent over the same period (Annexe-III.IV).

12. A state-wise analysis of certain key fiscal indicators shows a serious structural problem. The GFD, RD and revenue expenditure have substantially increased since 1997-98 while revenue receipts are increasing at a slower rate (Annexe-III.V). The component of salaries, pension and interest payments as a percentage of revenue receipts in 2001-02 has become very high. Similarly, the ratio of RD over GFD and aggregate expenditure over revenue receipts has also increased (Annexe-III.VI). The analysis of the data reveals that RD as a percentage of GFD is high in some States like Gujarat (81.4), Kerala (74.1), Tamil Nadu (67.9), West Bengal (66.0), Maharashtra (62.3) and Madhya Pradesh (60.2), above the combined average of 54 per cent for all States. These are the States which have been in WMA for more than 200 days in the recent years and whose resort to OD has been increasing in terms of both duration and amount. It is thus clearly established that the persistent liquidity problem which States are seeking to address through the means of WMA/OD is in fact manifestation of the chronic solvency problem requiring a different approach for its solution.

Chapter IV

Conclusions and Recommendations

1. The WMA facility of the Reserve Bank of India to the State Governments is intended only as a purely temporary assistance for meeting liquidity mismatches. It is not meant to be an additional or regular source of finance. Under Article 293(3) of the Constitution of India, borrowings by the States, either from the market or through negotiated loans, are fixed by the Government of India and this sets a limit on such source of funds. Utilisation of WMA as a regular source of finance bypasses this restriction.

2. The analysis of State finances reveals the problem of a widening resource gap. The resources available to the States have not increased concurrent with the increase in their expenditure commitments. State Plans have also grown on an incremental basis out of step with growth in revenue resources compelling the States to incur high cost borrowings. It is observed that even the approved borrowings have not matched the requirements of resources for Plan expenditure. This has exerted pressure on many States regularly to avail of higher amount of WMA and resort to OD on a near-permanent basis. It must also be recognized that WMA/OD is a non-transparent and concessional source of funds that encourages widening of the gap between expenditure and allocated resources. What should normally be the last resort has thus become the first and most preferred source of finance.

3. During the Committee’s interactions with the State Finance Secretaries, while recognising the perils of dependence on WMA/OD as a budgetary resource, some of them expressed their inability to forego this resource, at least in the medium-term. It was argued that until the necessary fiscal correction is carried out denial of this resource, which has already got integrated into the budgetary exercise, would disrupt not only the developmental activities of the States but also the minimum level of committed expenditure like salaries, pension and interest payments. The needed fiscal correction entails addressing a number of important issues concerning expenditure and receipts. This will require not only the initiative of the States themselves but action in areas encompassing Plan size, financing mechanism of the Plan, guaranteed bonds, negotiated loans, structural adjustments in administrative and public sector activities, reform of subsidy, transfers from the Centre (taxes, small savings, others) and the interest burden, falling under the purview of the Central Government, the Finance Commission and the Planning Commission. These issues are beyond the limited mandate of this Committee. In case it is considered that a short or medium-term credit should be made available in the interim period to the States pending overall structural correction, WMA / OD cannot obviously be a component of such an arrangement. The Committee, however, recognizes that unless a long-term solution to the serious fiscal problem of the States is found the demand for progressively liberalising WMA / OD regime will continue to be made. The Committee would like to reiterate that this will not be the appropriate solution as the liberalization of these facilities will accentuate rather than mitigate this problem. This clearly emerges from the analysis presented in Chapter III.

4. However, in the predicament in which many States are placed, the Committee feels obliged to continue the already prevalent liberal dispensation for some more time, pending the necessary fiscal correction. The Committee believes that this would not delay the corrective initiatives which are urgently required. It also hopes that the States will recognize that the WMA presently available is only a limit and not an entitlement.

5. The Committee would like to underscore the point that the road map for the future must not be the perpetuation or enlargement of the already adequate space provided in the liberal limits of WMA but to retract from the present trend of using it as a budgetary resource. The States will have to endeavour over time to revert to the use of the facility of WMA only for meeting the temporary liquidity mismatches rather than as a near permanent budgetary resource and to resort to OD only under exceptional circumstances. Greater concern for market judgements on the creditworthiness of the States would further reinforce the move in this direction.

Monetary and Other Implications

6. Net RBI credit to the State Governments by way of WMA and OD normally constitutes a small component of reserve money both in terms of the outstanding amount as well as growth variations. Instances of wide fluctuations in the size of OD, which affect variations in reserve money are, however, not uncommon. If the RBI’s credit to Government is too large, a situation develops in which attempts to curb monetary expansion at the same time begin to hurt the productive sectors of the economy because the credit needs of these sectors then suffers. Further, at times, when the Central Government has to bail out the States facing suspension of payments under the OD Regulation Scheme, its own WMA utilization goes up sharply with consequential augmentation to the reserve money. Such large and volatile increase in net RBI credit to the Central and the State Governments may often constrain the capability of RBI in its monetary operations as well as debt management. The increased utilization of WMA also has other macroeconomic implications for the country. In the context of the global integration of the financial markets, credit ratings are affected by the fiscal situation of the country as a whole. Increasing use of central bank finance by way of WMA/OD reflects serious financial stress of the States. Such sub-national fiscal situation can have an impact on the sovereign rating of the country.

Recommendations

Normal WMA

7. The Committee concurs with the assessment of the IAC that in considering an appropriate limit of WMA for the States, the objective must be to provide adequate space to meet the normal liquidity mismatches that arise during the year. In the Committee's view, such space already exists within the existing WMA limits. The IAC had taken revenue receipts and capital expenditure as the base for determining the WMA limits. The Committee examined on the possibility of simplification of the formula by linking WMA limits to a single variable. Most of the Finance Secretaries concurred with the use of revenue receipts as a base for computation of the WMA limits. The advantages of exclusively using revenue receipts as the base are: (a) it determines the repaying capacity of the States, (b) it is relatively transparent, (c) it is simpler to calculate, and (d) inclusion of capital expenditure tends to cause distortions because:

1. there are inter-state differences in computing capital expenditure;
2. not all capital expenditure that is incurred by the States need be from the Consolidated Fund of the State;
3. deficit on the capital account is camouflaged by carrying forward the unpaid bills on an incremental basis annually; and
4. there is likely to be far less mismatch between receipts and expenditure on capital account than in the case of revenue account.

It is recognized that from the point of view of the States, it is the adequacy of the limit to accommodate likely mismatches that is relevant and important. Therefore, exclusion of capital expenditure from the base could be compensated by adopting a higher ratio to the revenue receipts than the ratio presently used to determine the WMA limits.

8. The Committee, for purposes of computing the WMA limits, started with a premise of protecting the existing levels to which States have become accustomed. The distinction introduced by the IAC in computing the limits for WMA between the special and the non-special category States, given the peculiarities of the two categories of States, is being retained. The ratios applicable to revenue receipts (as the sole indicator) have been arrived at by the following methodology:

1. State-wise, ratios of WMA limits arrived at by the IAC to the three year average revenue receipts taken into account by them (1994-95 to 1996-97) were derived.
2. These ratios were uniformly adjusted upwards by the fraction of 0.15 on 2.25 for non-special category States and 0.15 on 2.75 for special category States. This was done to provide for the escalation introduced by the GFS in 2001 when the ratios prescribed by the IAC at 2.25 and 2.75, respectively were raised to 2.40 and 2.90, respectively.
3. The ratios for different States thus obtained were averaged out. The average so computed is 3.19 per cent for the non-special category States and 3.84 per cent for the special category States (Annexe-IV.I).

9. On the basis of the above mentioned ratios of 3.19 and 3.84 respectively, the Normal WMA limits proposed to be effected from April 1, 2003 have been computed (Table-2). It may be noted that the limits derived by applying the above formula have been rounded off to the next multiple of Rs.5 crore with a minimum limit of Rs.50 crore for any State. It may be observed that there would be an increase of 18.8 per cent in the aggregate WMA limits and the limits for almost all States would increase, though by varying degrees, in keeping with the trend in the revenue receipts. The Committee is conscious that these limits further enlarge the already adequate space for meeting the liquidity demands arising from mismatches between the receipts and expenditure. However, as these are only enabling provisions, the Committee hopes that with appropriate fiscal correction, the States will resort to using this facility to the limit only to the extent necessary. The ratio 3.19 per cent and 3.84 per cent of the average revenue receipts effectively work out to 38.28 per cent and 46.08 per cent of their average monthly receipts for the non-special category and the special category States respectively. A limit of this order should provide more than abundant cushion to cover the monthly liquidity problems that could arise even from any unexpected shortfall in devolution and transfer which, many States argued, were the main cause of their fiscal difficulties.

10. The Committee further recommends the following:-

1. The ratios as indicated in paragraph 8(iii) may hereafter be applied to the average of the latest three years revenue receipts - two years’ actuals and one year’s pre-actuals as approved by the Comptroller and Auditor General (CAG) - for annual revision of the limits to be effective from April 1 every year.
2. The formula and the limits may be reviewed in totality after receipt of the recommendations of the 12^th Finance Commission.

Table 2: Proposed WMA Limits effective April 1, 2003

(Rupees crore)

Sr. No	State	Current WMA Limits (2002)	Average Revenue Receipts for 3 Years (1999-00 to 2001-02)	Proposed WMA Limits with effect from April 1, 2003
1	2	3	4	5
	Non-Special Category States
1	Andhra Pradesh	520	19374.97	620
2	Bihar+	245	9431.01	305
3	Chhattisgarh+	100	3992.01	130
4	Goa	50	1127.49	50
5	Gujarat	445	15208.33	485
6	Jharkhand+	75	3226.95	105
7	Haryana	180	6320.00	205
8	Karnataka	375	14313.73	460
9	Kerala	225	8477.82	270
10	Madhya Pradesh+	275	10784.83	345
11	Maharashtra	760	28253.67	905
12	Orissa	185	6611.55	215
13	Punjab	235	7428.64	240
14	Rajasthan	310	11448.22	365
15	Tamil Nadu	415	17739.00	570
16	Uttar Pradesh+	630	23550.13	755
17	West Bengal	360	13070.33	420
	Total	5385		6445
	Special Category States
1	Arunachal Pradesh	50	1067.65	50
2	Assam	180	5403.42	210
3	Himachal Pradesh	115	3492.22	135
4	Manipur	50	*1096.62	50
5	Meghalaya	50	1076.33	50
6	Mizoram	50	926.88	50
7	Nagaland	50	*1323.76	55
8	Tripura	55	*1571.39	60
9	Uttaranchal+	50	*1643.41	65
	Total	650		725
	Total for All States	6035		7170

* Based on estimates as pre-actual figures for 2001-02 have not been received from the States.
+ In the case of reorganized States, the revenue receipts for 1999-00 and for first seven months of 2000-01 have been computed by using the revenue sharing formula. For the period December 2000 to March 2002, the data as given by the States have been taken into account.

Rate of Interest on WMA

11. The Committee recommends that the rate of interest charged on WMA should be:

1. Bank Rate for the period of 1 – 90 days and
2. 1 per cent above the Bank Rate for the period beyond 90 days.

The above differential rate is suggested mainly because the WMA limits as proposed are obviously larger than what would be needed by the States in normal circumstances to accommodate their liquidity problems and there must not be any incentive to utilize WMA for longer periods than what is necessary on account of its being a concessional source of funds. The Committee is aware that even the difference in rates of interest, as recommended above, does not really make this resource costlier than market borrowings or negotiated loans. This is, therefore, merely suggested as an indicator of the direction in which future corrective action should be undertaken.

Special Ways and Means Advances

12. Special WMA are given against the collateral of the investments by the State Governments in Central Government dated securities and Treasury Bills with RBI. RBI, after imposing certain margin requirements, revises the limits for special WMA on a quarterly basis for holdings of Central Government dated securities and on immediate basis for the variation due to investments/maturity of Treasury Bills. This scheme is working well. In order to encourage the States to build up reserves of Central Government securities which can be leveraged to raise collateralized funds from the RBI, the Committee considered it prudent to further liberalise the scheme with some safeguards. Accordingly, following recommendations are made:-

1. A uniform margin of five per cent should be applied on the market price of the securities. This could imply that the States could get advances amounting to 95 per cent of the market value of the securities. This would raise the operative limits since, at present, margins varying from 10 to 15 per cent are applied by RBI. The present practice of quarterly revisions for holdings of Central Government securities and immediate revision on account of variation in holding of Treasury Bills should continue.
2. The rate of interest on Special WMA should be at one per cent below the Bank Rate as against the present practice of charging interest at the Bank Rate.
3. Special WMA should be offered to the State Governments first. Only after having fully availed of these advances should the States be allowed to utilize the Normal WMA.

4. For operational convenience and timely revision of the drawing limits, the existing system of holding of investments in different offices of RBI should be streamlined.

5. Special WMA should continue as an exclusive scheme based on investments in Central Government securities which are unencumbered and should not include those securities which are covered under the Consolidated Sinking Fund, the Guarantee Redemption Fund or any other such special schemes.

Overdraft Regulation

13. It has been observed that a number of States have increasingly been resorting to OD for longer period in the recent years. After the enhancement of the WMA limits, greater resort to OD is a clear indication of fiscal imbalance and unless regulated in time, it would lead to a situation where the corrections would become costly and difficult. The bail-out of individual States, which used to be occasionally done by the Central Government in earlier years through advance releases, has become both more regular and more difficult. Further, bail-outs tend to open up criticism that the Centre is discriminating in favour of fiscally indisciplined States. While the OD provides a temporary cushion to withstand the adverse consequences of these structural problems, the problems only get exacerbated in the long run. The Committee would, therefore, caution that the persistent resort to OD is a symptom of a serious malaise which should not be ignored or allowed to be perpetuated. These issues have weighed with the Committee in dealing with the requests from some Finance Secretaries for further liberalization of the OD regulations. However, in view of the fact that a number of States get into OD frequently and many State Finance Secretaries have felt that such arrangements may have to continue in the medium-term till the fiscal corrections were put in place, the Committee purely as an interim measure was inclined to accommodate the States in terms of the duration of the OD.

14. As the WMA limits stand enhanced, occasions for resort to OD should become rarer and also the need for OD beyond 100 per cent of the WMA limit should be practically non-existent. If such resort to OD nonetheless occurs in case of any State, then it should be seen as an indication of a deep rooted fiscal and structural problem that demands urgent correction. Except in those cases, where the gap between available resources and expenditure commitments undertaken is too wide, such a situation would not arise. The past experience, in particular the data for the last two years, would substantiate this point. In the absence of immediate fiscal correction, unregulated resort to this facility compounds the problem and, in succeeding years, the problem only gets worsened. Under these circumstances, there cannot be any justification for enabling the States to avail of OD beyond 100 per cent of their WMA limit beyond five consecutive working days. One of the salutary recommendations of the IAC that would have arrested to some extent the utilization of this facility as a financial resource, outside the purview of Article 293(3) of the Constitution, was that of restricting the prevalence of OD within any quarter to not more than 20 working days. The Committee fails to understand why States cannot adhere to this principle, but for the fact that the OD has already become a resource rather than a facility to meet temporary and extra-ordinary liquidity problems.

15. Keeping in view the above aspects, the Committee recommends the following –

1. The total number of days that a State can remain in OD may be extended up to 14 consecutive working days from 12 consecutive working days at present. The two additional days are being recommended as many State Governments requested more time to arrange funds to clear the OD without disrupting their essential operations. It is also in keeping with the recommendations of the Sarkaria Commission. This extension in the existing time limit, however, is meant to be only for the short-term during the implementation of the Medium-Term Fiscal Reforms Programmes. With the reduction in time lag for cash inflows in view of on-going computerization in the banking sector and the State Government Treasury offices, the frequency of resort to OD must come down and the period of each spell of utilization should accordingly decline to 7 days or even lower.
2. The existing norm of restricting OD to 100 per cent of the Normal WMA limit should continue, i.e., if the OD exceeds this limit continuously for 5 consecutive working days for the first time in a financial year, the State will be advised by RBI to bring down the OD level and if such irregularity persists on a second or subsequent occasion in the financial year, RBI will stop payments notwithstanding the provision of permitting OD upto 14 days mentioned at (a) above.
3. The States should not be in OD in any one quarter for more than 30 working days. The quarter would be defined as a three month period beginning from April 1, July 1, October 1 and January 1 of every year. In case the State Government is in OD for more than 30 working days in a quarter, RBI and its agencies should stop payment of that State Government until the OD is cleared and no further OD should be permissible during that quarter.

The recommendations at (b) and (c) have been made because once OD becomes a resource to fund the gap between receipts and expenditure in a particular year, it becomes a recurring and growing necessity in subsequent years as resource mobilization does not catch up in short term while expenditure commitments persist. Therefore, such "hard budget" constraints are being recommended as a disciplining mechanism to avoid OD for long periods.

4. The committee recommends that the rate of interest on OD be as under:-

1. OD upto 100 per cent limit of WMA - three per cent above the Bank Rate, and
2. OD exceeding 100 per cent of the WMA limit - six per cent above the Bank Rate.

Thus, with a Bank Rate at 6.25 per cent at present, the OD upto 100 per cent of WMA limit would be at 9.25 per cent and for the OD that exceeds 100 per cent of the WMA limit, the rate of interest would be at 12.25 per cent. It may be noted that though the recommended increases are steep in comparison with the present rate, they are still lower than the present level of rates of interest of 13-14% which are charged on the negotiated loans.

Other Aspects

Dissemination of data

16. The Committee recommends that, as in the case of the Central Government, the RBI should disseminate data on net RBI credit to the State Governments – State-wise on weekly basis. This will provide transparency to the financial operations of the States. Many of the State Finance Secretaries have also agreed to this suggestion. In view of the sensitivity of the information, the Committee recommends that the RBI may consider an appropriate periodicity for their dissemination.

Transfers from Government of India

17. The State Finance Secretaries generally were in full agreement that two of the major factors contributing to liquidity problems, even after discounting the adverse impact of the deficit, were the abrupt shortfalls in actual monthly transfers from the Central Government to the States as compared to the budget estimates and the bunching up of releases of Plan funds for the Central Sector and Centrally-sponsored schemes, especially in the last quarter of the financial year.

18. As far as reduced transfers from the Central Government are concerned, it was observed that in certain years, abrupt and sudden reductions in the devolutions from the Centre to the States vis-à-vis the budgeted estimates had occurred because of shortfalls in collections. However, this has not been a common or regular feature and would either get corrected when the collections improve within the year or would have to be factored into the budget as a curtailment of the annual estimates of revenue receipts warranting proportionate expenditure cuts. The matter relating to releases from the Planning Commission are of a different nature. One of the complaints from the States was that a larger share of plan finances were given as earmarked funds on Centrally-sponsored schemes, that too outside the Consolidated Fund of the State, and that only a smaller share is being received as untied Plan loans. The related issue was that of bunching of releases in the last quarter whereas expenditure is incurred uniformly throughout the year. From the point of view of the Ministry of Finance / Planning Commission, such bunching occurs because of delayed certification of utilization by the States. These are issues that have to be examined by the Planning Commission and the Government of India. As far as their impact on the problem of cash management is concerned, the Committee feels that the liquidity crunch created by them, though genuine, can still be accommodated within the liberal WMA limit presently available to the States. As pointed out earlier, the recommended WMA limit works out to 38.28 per cent and 46.08 per cent of the monthly revenue receipts of the non-special category and the special category States respectively and the likely shortfalls would be very much of a smaller order than this.

19. During the deliberations, the State Finance Secretaries mentioned that the rising level of Plan size imposed compulsions on the State to incur larger borrowings from the market or from financial institutions in the wake of slower growth of revenue receipts. This is because the Plan size is determined based on an unrealistic estimate of balance of current revenues (BCR) and revenue projections. Sometimes resource gaps have been consciously bridged through high cost borrowings accentuating the fiscal distress. Further, the revenue component of the Plan expenditure has been increasing and, after successive Plan periods, has been contributing to steep increases in non-plan commitments. One alarming fact brought to the notice of the Committee was the increasing tendency of some States to resort to delayed payment of substantial amount of bills as a method of incurring expenditure beyond available resources. Such pattern of financing which is not captured in the fiscal statistics makes the published figure of RD and GFD unrealistic for that period. All these require a holistic review by the Finance Commission and the Planning Commission. It may be appropriate to consider fiscal consolidation for the States in serious fiscal problems for a specific period till the State finances recover rather than persist with an annual incremental growth in Plan size.

20. The Committee would like to highlight certain other related issues which were brought to its notice during the deliberations. The transfers from the Centre to the States on account of small savings have been rather erratic. The reason is that the Centre transfers to the States’ the collections made four months earlier. The mobilization under the small savings is seasonal with major accruals taking place in the months of June, September, December to March. The Committee, therefore, recommends that the Government of India consider transfer of collections of small savings to the States on a similar pattern as it does with the devolution of taxes, i.e., monthly transfers at the rate of 1/14^th of the estimated collections. This is expected to facilitate smoother cash management for the State Governments.

Interest payment at monthly rests

21. It has been mentioned to the Committee that some of the loan repayments especially for negotiated loans and interest payments are made on a quarterly basis. This accentuates the mismatch. The Committee, therefore, recommends that the loan repayments should generally be on a monthly basis and the interest payments including that on WMA and OD should also preferably be paid on a monthly basis.

Efficient Cash Management

22. It has been brought to the notice of the Committee that although the account position of the States is available on the website of the Central Accounts Section (CAS) of RBI, Nagpur to which State Governments have been connected and RBI regularly keeps the Governments informed whenever they get into OD, the efforts made by many of them in taking immediate corrective steps are far from satisfactory. Often the bail-outs by the Ministry of Finance are delayed to the last permissible day or even beyond. This causes serious operational problems at the level of RBI and its agencies including non-closure of the books at the CAS as per the prescribed time limit. Given such difficulties and keeping in view the recommendations regarding application of higher rate of interest on OD, it is imperative that the officials of the State Finance Department and the Ministry of Finance monitor the position regularly and take swift corrective action without waiting for the last day of the permissible OD period.

23. The Committee also recommends that the RBI, which operates the WMA scheme, help the States in improving their cash management techniques. This could be done through interactive workshops where the techniques of cash management could be discussed with the officials of the State Governments. The experience of States, who have evolved sound cash management practices (e.g. computerization and networking of Treasury operations, generation of regular MIS for follow-up, checklist for expenditure cuts in the event of fall in projected receipts, etc.) and have more efficient information system, may be shared amongst the other States in such workshops.

24. The Committee felt that certain suggestions for better cash management like issuance of short-term Treasury Bills and resource mobilization from the market out of an earmarked portion of the approved market borrowing programme, when the OD limit is breached, are not feasible, particularly in the context of the fiscal stress faced by a number of States. They also did not elicit any favourable response from the States.

25. The Committee also did not examine the issue and make any recommendation on the minimum balances being maintained by RBI because such balances are no longer linked with the fixation of the WMA limits and, in the current fiscal situation of the States upward revision in such balances can be deferred.