Governance & Fiscal Insights

Tag: economy

  • Beyond Deficit Targets: Re-Engineering India’s Sub-National Public Finance for Growth

    Beyond Deficit Targets: Re-Engineering India’s Sub-National Public Finance for Growth

    For over two decades, the core philosophy of macroeconomic management in India has been guided by a singular mandate: enforce fiscal discipline through strict numerical caps. Enacted through the Fiscal Responsibility and Budget Management (FRBM) Act of 2003 at the national level and subsequent Fiscal Responsibility Legislations (FRLs) across various states, these boundaries were designed to eliminate the “deficit bias” of governments, curb inflation, and secure long-term debt sustainability.


    However, an extensive empirical study by researchers Irsad, Mohd Yousuf Malik, and Syed Hasan Jafar evaluating India’s public finances from 1991 to 2022 exposes a deep structural flaw in this mechanism. The authors demonstrate an institutional “Decentralization Paradox”: while uniform fiscal rules successfully anchor stability at the national level, they create a restrictive trap that suppresses economic expansion at the sub-national (state) level.


    Fortunately, India’s public finance policy is undergoing a massive structural evolution. By connecting the historical baseline of that academic paper with NITI Aayog’s Fiscal Health Index (FHI) 2026, the legislative overhauls of the 16th Finance Commission, and the operational funding of the Central Government’s SASCI Scheme, we can map out how India is successfully shifting from rigid containment to a flexible, growth-centric framework.

    1. The Academic Diagnosis: The Simultaneous Model and the Capex Trap

    To untangle how legislative rules affect different tiers of government, the authors built a comprehensive Fiscal Performance Index (FPI) using Principal Component Analysis. This index aggregates six distinct variables to capture both revenue mobilization and expenditure quality:

    • Positive Indicators (Improve FPI): Own Tax Revenue to GDP/GSDP, Capital Expenditure to Total Expenditure, and Non-Tax Revenue to Total Revenue Receipts.
    • Negative Indicators (Degrade FPI): Fiscal Deficit to GDP/GSDP, Revenue Deficit to GDP/GSDP, and Interest Payments to Revenue Receipts.
      Because economic growth influences fiscal performance, and fiscal performance simultaneously impacts growth, standard statistical models face a “chicken-and-egg” dilemma of reverse causality. To resolve this, the authors deployed a Two-Stage Least Squares simultaneous equation framework. Instead of treating growth and fiscal health in isolation, the framework mathematically isolates the independent impact of legislative rules by controlling for external factors like the Terms of Trade, inflation, total outstanding debt liabilities, labor force expansion, and trade openness.

    The Core Findings:

    • The FPI Divergence (+0.14 vs. -0.04): The implementation of fiscal rules shows a significant positive coefficient of 0.14 with the national FPI, confirming that rules successfully consolidated central public finances. However, at the state level, it yielded a negative coefficient of -0.04, proving that rigid targets strip sub-national governments of the operational flexibility needed to handle local shocks.
    • The Expenditure Compression Trap: The model reveals that strict legislative rules trigger a stark growth penalty—-4.54 for national GDP and -5.09 for sub-national GSDP. When a state faces a revenue squeeze, it cannot easily reduce “committed expenditures” (salaries, pensions, and interest payments). To satisfy statutory deficit limits, it compresses the only flexible buffer available: discretionary Capital Expenditure.
    • The Multiplier Asymmetry (5.23): The framework shows that public investment holds an enormous growth coefficient of 5.23 at the state level, far higher than the 2.01 found at the center. Consequently, forcing states to trim infrastructure outlays directly penalizes long-term economic expansion.
    • Weak Growth Feedback Loops: The model proves that economic growth feeds back into fiscal health at a rate of 0.06 nationally, but a mere 0.01 at the state level. Sub-national governments cannot rely on national growth to clean up their balance sheets; their stability depends entirely on localized expenditure design.

    2. Mapping the Symptoms: NITI Aayog’s Fiscal Health Index 2026

    If the academic paper diagnoses a historical structural disease, NITI Aayog’s Fiscal Health Index (FHI) 2026 provides the active empirical proof. Tracking longitudinal trends over a clear decade-long baseline (FY 2014–15 to FY 2023–24), NITI Aayog organizes its ranking framework around Five Key Pillars that directly correlate with the variables identified by the academic paper.

    Structural Correlation: Academic FPI vs. NITI Aayog FHI 2026

    The Widening Sub-National Asymmetry

    The FHI 2026 results expose a massive divergence among major states, confirming the authors’ warnings about treating unequal states with uniform rules:

    • The Achievers: States like Odisha (which has topped the index for two consecutive years), Goa, and Jharkhand maintain excellent fiscal health. They consistently hold large capital outlays (around 4–5% of GSDP) and robust internal revenues, insulating them from expenditure compression.
    • The Committed Expenditure Trap: At the bottom, states like Punjab (ranking last with a score of 12.4 out of 100), West Bengal, and Kerala face severe fiscal distress. Their committed expenditures (salaries, pensions, and subsidies) absorb an overwhelming 50–60% of their total revenue receipts, leaving virtually zero fiscal space for developmental capex.

    Abandoning Uniformity: The North-East Decoupling

    In a direct implementation of the paper’s primary recommendation to abandon “one-size-fits-all” templates, NITI Aayog’s 2026 index completely decoupled the 10 North-Eastern and Himalayan states from the major states, ranking them on an independent grid. This officially recognizes that unique geographical isolation, sparse populations, and high service delivery costs require distinct, calibrated fiscal baselines.

    3. The Operational Antidote: The GoI’s SASCI Scheme

    To break the “capex compression trap” highlighted in the paper, the Central Government deployed a powerful operational counter-measure: the Scheme for Special Assistance to States for Capital Investment (SASCI).
    First rolled out by the Ministry of Finance in October 2020 during the pandemic revenue shock, SASCI acts as a countercyclical safety valve. It extends 50-year interest-free loans to state governments that are strictly earmarked for capital asset creation.

    How SASCI Resolves the Financial Dilemma:

    • Over and Above Limits: SASCI funds are provided completely outside a state’s normal Net Borrowing Ceiling. When local revenues contract, states can draw down these funds to sustain their core infrastructure pipeline without breaching their local FRL limits.
    • Excluding Revenue Leakage: The scheme explicitly bars states from utilizing these funds to bridge revenue deficits, cover interest burdens, or pay administrative salaries.
    • Targeting Structural Asymmetry: SASCI incorporates dedicated windows like the “Pride of Hills” allocations (safeguarding capital budgets for Himalayan states) and “Unity Malls” funding.
    • Upgrading Digital Governance: Reflecting the paper’s demand for deep public finance IT improvements, Part-IV of the SASCI scheme links funding to the mandatory integration of state treasuries with the Central Public Financial Management System (PFMS), establishing automated, end-to-end digital tracking of asset creation.

    4. The Legislative Overhaul: The 16th Finance Commission (2026–2031)

    While SASCI injects active capital into state budgets, the 16th Finance Commission framework provides the long-term legislative architecture designed to change sub-national incentives for the 2026–2031 allocation period.

    1. Re-Engineering the Devolution Loop: The 10% GDP Weight

    The 16th Finance Commission maintained the vertical devolution share to states at 41%, but introduced a major modification to the horizontal distribution criteria: a 10% weight for a state’s direct contribution to nominal GDP, replacing the older, generic “tax effort” metric. This directly addresses the paper’s finding that growth feedback loops are structurally weak for states (0.01). By rewarding GSDP expansion, the commission ensures that states that drive local economic engines are automatically compensated with a larger share of untied central taxes.

    2. Eliminating the Revenue Deficit Crutch

    The commission has systematically discontinued open-ended post-devolution Revenue Deficit Grants, pivoting central transfers heavily toward Performance-Based Grants. This penalizes states that rely on central adjustments to finance daily operational deficits, forcing them to focus on the paper’s primary positive variable: expanding their Own Tax Revenue.

    3. Clamping Down on Off-Budget Liabilities

    To prevent states from window-dressing their balance sheets, the 16th Finance Commission formalizes strict rules regarding hidden debt. All off-budget borrowings incurred by states through public sector undertakings (PSUs) or special purpose vehicles must be fully adjusted against their Net Borrowing Ceilings under Article 293(3). This creates absolute accounting transparency, forcing hidden liabilities back onto the primary balance sheet and creating a true, verified baseline for macro-fiscal performance evaluation.

    5. The New Era of Fiscal Federalism

    The clear convergence between academic research, NITI Aayog’s diagnostic indexing, and active central policies reveals a significant shift in India’s macroeconomic philosophy. The era of treating deeply unequal states with rigid, identical budget rules is drawing to a close.
    By protecting high-multiplier capital expenditure via SASCI, clamping down on off-budget window dressing, decoupling unique regional economies, and directly rewarding states for their nominal GSDP contributions through the 16th Finance Commission, India is successfully forging a new model of cooperative federalism. This balanced approach preserves macro-discipline at the top while safeguarding the structural growth engines of the states below.

  • A Shrinking Slice of the Pie: Why Rajasthan Must Act Fast on Urban Revenues

    A Shrinking Slice of the Pie: Why Rajasthan Must Act Fast on Urban Revenues

    The financial health of India’s cities is increasingly dependent on their ability to generate Own Source Revenue (OSR), which consists of taxes and non-tax revenues that Urban Local Governments (ULGs) have the legal authority to levy and collect. For the Urban Local Bodies (ULBs) of Rajasthan, navigating municipal finance presents a unique paradox. On one hand, the state boasts some of the most progressive legal and valuation frameworks in the country. On the other, it struggles with a highly depressed tax base heavily influenced by massive tax exemptions and broader demographic factors.

    However, recent shifts in national funding policies—specifically the mandate of the 16th Finance Commission (FC-16)—make it clear that Rajasthan can no longer afford to ignore its OSR deficits, regardless of its urbanization levels.

    The Urbanisation Hurdle: A Structural Disadvantage

    At a macroeconomic level, a city’s ability to mobilize OSR is heavily tied to its degree of urbanization and economic base. Rajasthan is officially categorized as a “less urbanised large state,” meaning it has an urban population of less than 30% alongside a total population exceeding 35 million.

    Data shows a direct, positive correlation between the level of urbanization and a municipality’s ability to generate its own revenues. For instance, metropolitan ULGs in more urbanized large states collect nearly 3 times the OSR of metros in smaller urbanized states, and a staggering 10 times that of metros in less urbanized states like Rajasthan . Consequently, Rajasthan’s ULBs inherently face a lower baseline revenue generation potential and structurally require more support for both operational and capital expenditures.

    Self-Inflicted Wounds: The Cost of Massive Exemptions

    While low urbanization naturally limits revenue buoyancy, Rajasthan severely restricts its own potential through highly generous tax policies. A major constraint on the state’s OSR mobilization is its policy of granting unusually large size-based exemptions for property taxes.

    The state currently exempts all residential properties below 2,700 square feet and all commercial properties below 900 square feet. This creates a highly depressed tax base, severely limiting revenue potential. To put this in perspective, jurisdictions under the Mumbai Municipal Corporation Act only exempt residential properties below 500 square feet. Because of these massive exemptions, property tax contributes less than 10% of the total OSR for Rajasthan’s ULBs, and the state’s ULB OSR as a percentage of its non-primary Gross State Value Added (GSVA) sits at a mere 0.18%, lagging far behind leading states like Maharashtra (1.40%) or Gujarat (0.84%).

    The 16th Finance Commission: A Wake-Up Call

    The urgency for Rajasthan to overhaul its municipal finances stems directly from the 16th Finance Commission (FC-16), which has explicitly recognised urbanisation characteristics and made accelerating urban growth a central focus of its grants-in-aid. To incentivize speedier urbanisation, FC-16 shifted the macro-allocation of total local body grants between Rural Local Bodies (RLBs) and ULBs to a 60:40 ratio.

    However, the methodological changes introduced by FC-16 structurally disadvantage Rajasthan.

    Under the new FC-16 formula, Rajasthan’s inter se share for the ULB grant pool is fixed at 5.21%. The shift from a formula that rewarded geographical size to one that rewards urban population size and municipal revenue generation strongly indicates that Rajasthan has lost its previous structural advantages in securing urban grants.

    Silver Linings: Progressive Frameworks to Build Upon

    Despite these formidable challenges, Rajasthan presents a mixed picture because it has already implemented critical, politically difficult reforms that many other states lack :

    1. Capital Value (CV) Method for Property Tax: As of 2025, Rajasthan is one of only seven states in India to transition to the Capital Value method for levying property tax. This superior methodology ensures that property taxes are a buoyant source of revenue because it links the taxable value directly to state-notified guidance values or circle rates, reflecting actual market rates.

    2. Legal Mandates for Water Cost Recovery: Rajasthan is one of only six states that have successfully implemented legal frameworks explicitly linking the setting of water tariffs to Operation and Maintenance (O&M) cost recovery. This protects the state from the severe under-pricing that plagues the 13 other states lacking such mandates.

    Pathways Forward: How Rajasthan Can Augment OSR

    To survive the fiscal shift brought by the 16th Finance Commission and ensure fiscal sustainability, Rajasthan must leverage its progressive frameworks and focus on specific levers to augment OSR:

    • Roll Back Size-Based Exemptions: The most immediate fix is expanding the tax net by significantly lowering the massive exemption thresholds for residential and commercial properties, allowing the excellent CV valuation method to actually capture revenue.
    • Enforce the Water Tariff Frameworks: Rajasthan must actively use its existing legal mechanisms to ensure water tariffs are formulaically linked to O&M costs, addressing the historical under-pricing of utility services.
    • Monetize Municipal Assets: ULBs should create comprehensive, geo-tagged digital asset inventories of municipal lands and buildings, and establish robust legal frameworks to link rental income to market values.
    • Leverage Land Value Capture (LVC): By integrating urban planning with finance, Rajasthan’s ULBs can tap into financial windfalls generated by public infrastructure projects through development charges and betterment levies.

    Conclusion

    Rajasthan cannot change its current urbanization levels overnight. However, it has total control over its municipal tax policies. By removing archaic property tax exemptions and fully utilizing its modern valuation and tariff frameworks, Rajasthan can overcome its structural disadvantages, improve its OSR buoyancy, and secure its rightful share of national urban development funding.

  • What if a state’s real liabilities are larger than what its budget appears to show?

    That is the central concern with off-budget borrowings.

    A WorldBank study for the 16th FinanceCommission notes that these are borrowings raised by PSUs, SPVs, or other government-controlled entities, where repayment is ultimately supported by the government through grants, guarantees, or escrow of future revenues. So the borrowing may sit outside the budget, but the fiscal risk does not.

    The root cause is fairly clear: persistent subsidy pressures, loss-making public utilities, and infrastructure financing needs. Off-budget routes allow expenditure without fully reflecting the burden in the budget, which weakens fiscal transparency and creates hidden debt.

    Why is this worrying? Because reported figures themselves are often incomplete.

    The study found major gaps between what some states reported and what emerged from CAG-based reporting. For FY2021–22, TamilNadu reported ₹594 crore of OBBs, while the CAG-linked figure cited in the study was ₹12,357 crore. WestBengal reported ₹1,089 crore, against ₹4,311 crore in the CAG-linked figure used in the study. It also clearly states that there is no independent institutional mechanism to validate reported OBBs, and many cases may be underreported or missed altogether.

    That is what makes hidden liabilities especially dangerous: they weaken the credibility of deficit and debt numbers, complicate compliance with FRBM limits and eventually return as explicit fiscal pressure.

    One reform path already exists– The study highlights Karnataka’s approach of broadening the definition of liabilities under its fiscal responsibility legislation to include PSU/SPV borrowings. That is the right principle: if public resources will ultimately service the liability, it should not remain outside the state’s fiscal lens.

    The wider recommendations are equally important: a uniform reporting framework, separate disclosure of guarantees, grants and loans, annual reporting of escrowed revenues/revenue forgone, better lender-wise disclosures, and modernization of the accounting framework.

    Off-budget borrowing is not just an accounting issue. It is a fiscal governance issue.

    When liabilities are moved outside the budget, accountability also moves with them. And that is precisely why transparent reporting matters.

  • When the Safety Net Is Gone and Borrowing Space Is Nearly Exhausted: A Fiscal Question for Rajasthan

    When the Safety Net Is Gone and Borrowing Space Is Nearly Exhausted: A Fiscal Question for Rajasthan

    Public finance often looks technical from a distance. But sometimes, one policy shift captures a much larger story.

    A simple way to understand the present moment is this: what happens when a government can no longer rely on a fiscal safety net, while at the same time its room to borrow is already becoming narrow?

    That is the broader question emerging from the changing treatment of Revenue Deficit Grants in the Finance Commission framework, especially in the context of Rajasthan.

    The 15th Finance Commission: A Significant Revenue Deficit Cushion

    Under the 15th Finance Commission, Rajasthan was recommended total grants-in-aid of ₹59,374 crore for the award period 2021–26. Out of this – ₹14,740 crore was recommended as Revenue Deficit Grant This was about 24.83% of the total grant-in-aid The full recommended amount was released.

    This is an important point. Revenue Deficit Grant was not a minor component. It was a substantial part of the overall support package. In effect, it acted as a cushion for the State’s revenue-side imbalance.

    The 16th Finance Commission: A Clear Policy Shift

    For the 16th Finance Commission award period, the total grant-in-aid recommended to Rajasthan is stated to be ₹53,357.75 crore. But the more notable shift is this- No Revenue Deficit Grants have been recommended for the award period of 16th FC.

    That is not merely a change in one line item. It suggests a deeper shift in fiscal philosophy.

    The idea appears to be that States should increasingly manage their own revenue gaps through internal correction rather than through recurring external compensation.

    Why This Shift Matters – Revenue Deficit Grants were meant to support States where revenue expenditure exceeded revenue receipts. When such support is available, it provides breathing room.

    When that support is withdrawn, the expectation changes.The burden then shifts more directly toward: improving tax effort, increasing tax efficiency, rationalising expenditure, containing revenue spending, strengthening internal fiscal discipline

    In other words, the framework moves from supporting the deficit to forcing correction of the deficit. Rajasthan’s fiscal capacity faces a double pressure. This transition becomes more significant when seen alongside Rajasthan’s debt position.As stated: the FRBM ceiling for debt is 38.2% of GSDP as per the Finance Accounts for FY 2024–25, the State’s actual debt is already accumulated at 37.1% of GSDP.

    This creates a real double pressure on fiscal capacity. On one side: Revenue Deficit Grant support is no longer available. On the other side: remaining borrowing space is limited. That means the State cannot comfortably depend either on a revenue-gap grant cushion or on large additional debt space. Fiscal adjustment, therefore, has to come increasingly from within the system.

    A larger change in fiscal federalism seen together- these developments indicate a broader transition in India’s fiscal federalism. Earlier approach supported States through revenue gap funding but emerging approach- expect States to correct deficits through their own fiscal management. This reflects a move away from compensating persistent imbalances and toward encouraging structural correction. Whether this shift will strengthen long-term fiscal resilience or deepen short-term stress is a separate debate. But the direction of policy is becoming clearer.

    The Core Question Ahead

    For Rajasthan, this is not just an abstract policy matter. It has direct implications for:- budget management, expenditure prioritisation, subsidy rationalisation, tax administration, fiscal sustainability.

    The real question is no longer only how much support a State receives. The more important question is this:

    How should a State respond when grant support reduces, borrowing headroom narrows, and fiscal adjustment has to come increasingly from within?


    Reduced fiscal cushion. Limited borrowing room. Greater pressure for self-correction.

    That is where the next phase of the public finance debate is heading.