Hyderabad: In the last few months, there seems to be a sudden and serious interest in making India a USD 5 Trillion economy by 2024 or, in the next five years.
There is welcome albeit, extreme optimism in different stakeholders that this can be achieved. Napoleon had once stated, “nothing is impossible”. Hence, it is always good to be optimistic and hopefully, India will achieve that target while attaining inclusive growth.
Hopefully, as our economy grows it will not be so imbalanced like the Latin American Economies where economic growth has also led to high income disparities. An important component of the more than doubling of the size of the Indian economy needs to get one thing right: the economic health of the States of the Indian Union needs to dramatically improve.
This is important because money spent by the states tends to have a higher multiplier economic effect than that compared to the spending by the central government. For sake of the larger good of the Indian nation all of us should hope that all the political parties, especially the ruling parties in the states and the centre will come together to help the economy.
The practical reality is that the States of the Union may be reaching a time when they need to ask tough questions and review their whole economic model before it is too late. They have reached a point where postponing tough decisions will yield results that will only lead to deterioration of their financial health. It is in the interest of the states’ to change their underlying economic fundamentals.
Any increase in the doubling of the economy requires all segments including agriculture, manufacturing, services and exports to grow. Our economic growth has been based on growth in the low end service sectors of the economy, massive increase in debt by all levels of the government which was then spent without sufficient growth in labour intensive manufacturing or agriculture or investments in infrastructure.
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Even the government spending was not based on large scale investments that would help in the creation of value added services. Instead, successive governments were happy as long as headline GDP growth increased. The result is that consumption increased thanks to debt, government spending and growth of lower end of the service sector but it was insufficient to remain globally competitive – especially at a time when technology is changing rapidly and when high end value added services are the only way to increase competitiveness in the economy.
Problem: Worrying Expenditure and Borrowings
The problems for the Indian states start with the nature of their expenditure and borrowings. Net value addition in the economy has not even doubled in the past 10 years. The number of factories in the states has grown only marginally in the period 2014-17 (figures beyond that have not been given).
They would likely have declined due to the impact of demonetisation and GST. Interestingly, the highest growth in the number of factories in the country was from 2010-14. Tragically, gross capital formation of all the states combined together has declined over the period 2012-13 to 2016-17.
Even government statistics indicate that the economy was recovering before it was severed damaged by the twin blows of demonetisation and problematic GST implementation. A major problem in the economic health of the states’ is that while their expenditure and interest payments are growing rapidly, their own revenues are growing far too slowly to support the large increase in expenditure.
States own tax revenues has grown from Rs.30,300 crores in 1990-91 to Rs.11.99 lakh crores. Since 2014-15, states’ own tax revenue has grown from Rs.7.80 lakh crores to 11.99 lakh crores – a growth of around 35% while liabilities and expenditure is growing much faster.
Problematically, states are over-estimating their likely incomes when presenting their budgets and in the hope that their incomes will increase are spending more and more money. The states are sleep walking into a financial crisis.
As a generalisation, one of the biggest changes that are needed is that the States have to become more responsible in their borrowings and the use of debt. Fiscal prudence is the need of the hour.
This becomes more urgent because the overall world economy seems to be at its weakest point since the Global Financial Crisis of 2008.
That means a decline in global growth will only huge challenges that will hurt most of the industries which in turn will impact consumption and economic activity and by extension revenues of the states.
Recent RBI data indicates a worrying picture in most of the balance sheets of the states. The outstanding liabilities of the states have exploded. Since 1991, there has not been a single year when the total outstanding liabilities of the states have declined or remained constant from the previous years – they have always risen. They have increased from Rs.1.28 lakh crores for all the states in 1991 to Rs.45.408 lakh crores at the end of March 2019.
Outstanding liabilities have almost doubled from Rs.24.71 lakh crores in March 2014 to Rs.45.40 lakh crores in 2019. Invariably, interest payments have exploded from Rs. 8,660 crores in 1990 to Rs.3.154 lakh crores at the end of March 2019. Salaries, pensions and debt repayments are now taking up most of the resources of the states. Pension and other liabilities are increasingly growing unmanageable for the states.
Not only is the deficit rising when there is no commensurate rise in incomes. Instead we are seeing irresponsible schemes and borrowings to sustain the payment of salaries, pension and repayment of old debts.
The case of AP is interesting: the pension liabilities in the state increased from Rs.330 crores in 1990-91 to Rs.13,600 crores just before bifurcation in 2013-14 but by 2018-19 it was budgeted at Rs.15,200 crores for Andhra Pradesh alone while in the case of Telangana it is Rs.11,700 in 2018-19. In other words, for both the states together it has near doubled since bifurcation – a rate of growth that practically not sustainable. As a generalisation, these problems are compounded when the economy slows down – a stark reality that we staring at.
Unfortunately, most state governments think that they can win votes by constantly raising subsidies for the general populace, salaries, pensions and perks for their employees without a commensurate increase in resources and investments that generate sufficient economic activity – all of which is to win votes.
The tragedy of the fiscal policy of many states is that they are continuously increasing salaries by way of pay commission revisions even when they have no resources and without increasing the productivity of their labour force.
In many cases, Indian states have reached a position wherein they constantly need an overdraft from the Reserve Bank of India to survive the month. Overdraft facility was started by the RBI as an emergency source of funding but thanks to irresponsible policies it has become an important part of fiscal management.
Changes Needed
The reason why the states have got into this mess is because of the problem in the design of their social schemes. States have concentrated on giving patronage to their voter base in the guise of policies that will alleviate policies. Statistics indicate that there is an urgent need for the government to completely overhaul their social expenditure.
Most importantly there is an urgent need for the State Governments to drop the concept of “Saturation approach”. Such a saturation approach has led to increased leakages. The justification for a review of social expenditure is necessitated because when distributing these subsidies, the states are not considering increase in incomes and the huge expenditure that has been spent: in 1990-91 the total expenditure on the social sector was Rs.35,130 crores and reached Rs.14,90,410 crores.
Ironically, this expenditure on social sector has nearly doubled in five years: from Rs.8.30 lakh crores in 2014-15 to Rs.14.90 lakh crores in 2018-19. An important but simple question that needs to be asked is why is there so much poverty even though all the states are still spending nearly Rs.15 lakh crores every year.
There is no doubt that social expenditure is needed but it needs to be spent in such a manner it helps the overall economic and social needs of population. Subsidies to the old, very young and needy are something that are welcome and in fact good for the economy as long as there is no social security net.
However, it does not make any economic sense for a state to borrow money and give unproductive subsidies – especially to those who are in their prime working age or to encourage consumption of unproductive goods and services. Such large scale borrowings by the governments invariably tend to starve economic enterprises of money in the form of loans. Nobody can say that subsidies are bad. Subsidies become impossible when states start living beyond their means.
The second important reform needed is that it important to push for the growth of bond markets instead of depending on the banks. The good thing is that the Central Government is pushing the states towards market borrowings. But the benefits are being negated by the fact that insurance companies, banks and others are subtly forced to lend to the states in various ways including regulatory compliance issues.
This means that the banks are forced to lend borrow even to states even when they know that the most indebted states are taking new loans to repay old loans – a dangerous sign for any banker.
The deeper bond markets grows, the more possibility that irresponsible behaviour will not be tolerated because nobody would lend to a state which may not repay money simply because it is not generating enough revenues to cover their expenditure.
Change before it’s too Late
There is an urgent need for the Central Government to advice caution by looking beyond vote bank politics and political niceties. The centre needs to convince the states that fiscal prudence is in the longer-term economic interest of their own people. Unless Central government initiates urgent reform, any further postponement of the inevitable may only mean that the fiscally troubled states have to take more drastic and bitter medicines in the future than they will have to do so today.
The States also have to understand that under the Constitution, the Central Government has the powers to crack the whip in case of problems by using Article 360 of the Constitution. Article 360 clearly declares that “If the President is satisfied that a situation has arisen whereby the financial stability or credit of India or of any part of the territory thereof is threatened, he may by a proclamation make a declaration to that effect”.
If it does lead to such an eventuality, then all obligations of the states’ including salaries, pensions and debts will be affected. Hopefully, the states will not take their populations in that path. That would be worse than course correction today itself.
(Written by senior economist Dr.S.Ananth. This is an opinion piece and the views expressed above are the author’s own. ETV Bharat neither endorses nor is responsible for the same.)
