According to a recent RBI report, states like Punjab, Rajasthan, Kerala, West Bengal, Bihar, Andhra Pradesh, Jharkhand, Madhya Pradesh, etc. have a high debt burden. The cumulative debt of states has risen from 19.1 percent in 2018-19 to 25.1 percent in 2021-22. While fiscal stability of states is necessary for sound sub-national fiscal health, there are persisting issues regarding it.

They are as follows:

• Declining revenues of states: The share of states’ own revenue has declined from 69 percent in 1955-56 to below 38 percent in 2019-20 due to slow pace of tax revenue growth. Also, there is a loss of autonomy on tax rates under the GST regime. Additionally, the COVID-19 pandemic has further impacted the tax revenues of states.
• High state expenditure: States have limited fiscal capacity and high share of committed expenditure for socio-economic development and populist measures like farm loan waiver, subsidies, etc. Other committed expenditures include interest payments on debt, pensions and administrative expenses.
• Implementation of Centrally Sponsored Schemes: It increases the burden on states to allocate their respective share for these schemes.
• Contingent liabilities: Due to the growing trend of using state PSUs, SPVs and other equivalent instruments for off-budget borrowings, the liabilities of states are increasing over time.
• High DISCOM losses: High debt levels of DISCOMS have been contributing to the debt burden of states.
• Legal loopholes: State governments resort to extra-budgetary borrowings to finance their populist measures and this debt is concealed to circumvent the FRBM target.

Measures that need to be taken for long-term stability of state finances include:

• Improving fiscal discipline through expenditure prioritization, debt consolidation and FRBM compliance. The FRBM also needs to be amended to cover all the liabilities of the government.
• Cap excessive spending and borrowings at sectoral levels to avoid excessive populism, and their negative spill-overs on other areas.
• Rationalization of Centrally Sponsored Schemes to allow more flexibility to states and UT’s in their implementation to meet their domestic needs.
• Raising additional resources at the sub-national and national levels to increase the tax-to-GDP ratio, which is around 17 percent. Also, there is a requirement of addressing issues on GST compensation continuity, and shrinking of net divisible pool.
• There is a need to curb the black economy, as it erodes the fiscal pool of the government and leads to suboptimal spending.