Abstract
Chapter 2 Review of Literature
2.4 Fiscal and Debt Sustainability of the State
widening the tax base, reducing the loopholes and increasing the productivity of non-tax revenue. Proper emphasis on revenue effort by the state governments in India may help them to generate more revenues. Considering the above fact, various studies recommended for incentive based transfers from Finance and Planning Commission of India. Reduction of unnecessary tax breaks or tax concessions may also help a government to generate more revenues as tax concessions or tax breaks as used by various countries to attract foreign investment are not found to be beneficial for the respective governments.
does not exceed the present discounted value of future revenues net of non-interest expenditures). Wyplosz found this approach of debt sustainability to be sophisticated, but he pointed out that any debt sustainability assessment was valid within limited time period due to uncertainty of future.
Buiter and Patel (1992) in their study on Central Government in India which covers the period from 1970 to 1990 came out with two principal conclusions. First, continuation of the same fiscal behaviour would eventually threaten the solvency of the government and in turn sustainability. Second, the option of using the seignorage or inflation tax to bridge part of the budgetary gap was limited and as a result, small sustained increase in the share of the seigniorage in GDP had a high cost in terms of additional long term inflation, and even maximal use of inflation tax would insufficient to close the solvency gap.
Gulati (1993) in his study found that during 1980s, the combined debt of the central and state governments in India grew at the rate of 18 per cent per annum as against the GDP growth rate of 14 per cent. The increase in internal public debt was almost six times (5.84) during the period which was a matter of concern for both the central and state governments. Gulati was aware of the adverse impact of excess public borrowing and gave importance on fiscal consolidation. But according to him, restriction of public borrowing should not be at the cost of social obligations and economic growth. He was of the view that to reduce the burden of public debt by reducing the government’s required expenditures may well amount to reneging on its obligations. Instead of that, government should explore different ways of mobilizing additional current revenues such as larger recoveries in the form of interest receipts, dividends, and reduce the net outgo on account of interest on public debt. He was of the view that government should give importance on economic growth which leads to more generation of revenue even at a lower tax rate to meet the larger magnitude of the debt.
Chelliah (1996) was of the view that the uninterrupted and rapid growth of public debt in India during 1980s and early 1990s was only a manifestation of the deepening fiscal crisis.
The writer was of the view that public debt grew very rapidly both in absolute and in relation
to GDP. He was in favour of urgent steps on the part of governments for reduction of deficits and interest burden.
Olekalns and Cashin (2000) had made a study on sustainability of Indian Fiscal policy covering a period from 1951-52 to 1997-98 by using conintregration and stationarity test.
Their study found that India had a long history of running fiscal deficits and magnitude of these deficits had violated the intertemporal budget constraint. There was no evidence of cointegration between central government’s tax revenues and expenditures implying a violation of intertemporal solvency and sustainability. Based on their study, they concluded that fiscal policies of the central government were unlikely to be sustainable in the long-run and need to be altered to prevent the adverse response from the lenders.
Kopits (2001) carried out his study at the time of state-level fiscal crisis in the later part of nineties of previous century. He observed that India’s public deficit bias and indebtedness cannot be sustained for a long time. Thus, he was in favour of adopting fiscal responsibility legislation with a high degree of transparency and well designed fiscal policy rules.
Gurumurthi (2002) in his paper found that debt relief schemes as provided by Tenth and the Eleventh Finance Commission of India were insufficient to deal with the magnitude of the debts of state governments. He was in favour of addressing the issue more seriously while drafting the terms of reference of the Finance Commissions.
Moorthy (2004) in his paper on state governments in India found that despite the existence of primary deficit in the later half of the 1990s, interest rates were favourable. The initiative by central government to swapped high cost debt of state governments to low cost debt was found to be the main contributing factor for favourable interest trend during that period. The author was of the view that this should not be considered as long term solution as for long term sustainability; both the central and state governments must give importance on primary surplus.
Prasad et al. (2003) in their study showed that given high level of contingent liabilities of the state governments in India, some sorts of corrective measures were inevitable. They were against the policies of central public sector undertakings and central government to provide bailouts though write-off and waivers of loans and interest to avoid moral hazard problem.
The favourable interest rate environment of the state governments in the recent decades, according to them, was not likely enough to offset the worsening primary deficit. They were in favour of giving more emphasis on primary surplus to reduce interest payments, fiscal deficit and revenue deficit. Their view was that fiscal responsibility legislation was not adequate enough to offset the fiscal disabilities because emphasis was not given on primary deficit. If the priority was to resort to borrowing to incur capital expenditure, then the Fiscal responsibility legislation should aim to keep the primary deficit under control.
Rangarajan and Srivastava (2004)in their paper had examined the long term profile of fiscal deficit and debt relative to GDP in India, with a view to analyze the sustainability issues along with the considerations relevant for determining suitable medium and short-term fiscal policy. They opined that the impact of fiscal deficit and debt on growth and interest rates that arises from their effect on saving and investment was critical in any examination of fiscal sustainability. They argued that large structural primary deficits and interest payments relative to GDP have had an adverse effect on growth. Along with that, large revenue deficits amount to reduction in government savings, which may not be fully offset by a corresponding rise in the private savings, lead to a fall in the overall saving rate. They studied the impact of fiscal deficit on both private and public investments. They opined that the adverse effects on private investment occur if fiscal deficits put pressure on interest rates, and if private investors are sensitive to the interest rate. The effect on government capital expenditure is through committed interest payments, which rise if the debt-GDP ratio rises.
They were in favour of two phases to bring stability in the fiscal stance of both centre and states. In the adjustment phase, fiscal deficit should be reduced in each successive year until revenue deficit, and correspondingly, government dissaving, is eliminated. In the second phase, fiscal deficit could be stabilised at some percent of GDP or GSDP. The debt-GDP ratio would eventually stabilise and in this process, the ratio of interest payments to revenue
receipts will fall, enabling a progressively larger amount of primary revenue expenditure to be incurred on social sectors.
Lahiri and Kannan (2004) were of the view that there was a widespread unanimity about the unsustainability of the Indian fiscal stance at the later part of 1990s. They identified the crucial issues relating to debt such as the composition of the deficit, the growing debt which is nothing but the accumulated deficit over the past, the growing interest burden on public debt and financing a part of the deficit through borrowings from the Reserve Bank of India.
The author was of the view that inability to garner more revenue and contain unproductive expenditure created the burden of adjustment on capital expenditure and critical items such as operation and maintenance expenditure.
Rajaraman et al. (2005) had made a state level fiscal sustainability analysis in India. On the basis of their study on Indian states, they concluded that excessive borrowings by state governments by utilizing the sources such as borrowings from financial institution and National Small Savings Fund led to unsustainable debt at the state level. To deal with the problem, they recommended for inclusion of the entire borrowing by the state governments under article 293(3). They were of the view that, as public debt accumulated, there was legitimate concern over whether the governments were in a position to service its debt.
Ultimately, when financial markets perceived that the debt stock of any government was unsustainable, further lending to that government had ceased. Proper debt sustainability approach helped a government to prevent such a situation. They opined that assessment of fiscal sustainability analysis has to be carried out through multiple dimensions such as primary deficit GSDP ratio, interest payments revenue receipts ratio etc.
Rath (2005) had made a debt sustainability assessment of Orissa with the help of Domar model. The study which covers the period from 1990-91 to 2002-03 found that the fiscal position of the state was insolvent during that period. This was due to the fact that the although growth rate of GSDP was found to be greater than growth rate of average interest payments on public debt, but was less than growth rate of public debt. It implied that the state had fulfilled the sustainability condition but did not able to fulfill the solvency condition. On the basis of these findings, he came out with the conclusion that debt sustainability of Orissa
was uncertain in future, as solvency condition was not satisfied. This might lead to excessive debt GSDP ratio and weaken the fiscal sustainability aspect of the state.
Rajaraman and Mukhopadhyay (2005) in their paper had examined the time series properties of debt GDP ratio of India in undiscounted terms using structural time series model. Their study which covered the period 1952-97 found that there was an immediate need for fiscal correction in India to preserve public solvency.
Rakshit (2005) reported that the most serious weakness of the Indian macroeconomy in recent decades lies in the large and persistent fiscal deficits. He was of the view that large deficit and interest payments stand in the way of provision of essential public goods and development expenditure. The author found that the macroeconomic role of the budget deficit underwent radical changes by the early 1970s. Along with the sustainability issues, economists were increasingly worried about crowding out and other adverse consequences of fiscal deficit. The author was of the view that Domar condition of sustainability rather than solvency criteria or Ricardian equivalence provided a better approach to analyze the consequences of budget deficits or sustainability of debt financing.
Srivastava (2009) in his study found that the indebtedness of Indian states grew sharply during the later part of 1990s. His study revealed that the overall debt GSDP ratio had increased from 21 percent in 1997 to 33.5 percent in 2005 implying an increase of 12.5 percent in a period of seven years. The author was of the view that the rising debt in the 1990s was mainly due to the implementation of the Fifth Central Pay Commission’s recommendations, a sharp rise in nominal interest rates towards the end of 1990s, and slow growth in the first three years of the 1990s. The author observed that overall environment for states’ borrowings had been considerably changed after the recommendation of the Twelfth Finance Commission as states had been asked to raise their loans directly from the market through the RBI. Along with that, the states had been given a major one-time debt relief by consolidating and rescheduling their outstanding debt to the central government provided that they enact fiscal responsibility legislation with given conditionalities. These recommendations, according to him, have implications for the future debt path of the states.
Ramesh and Shanbhogue (2010) had made a critical analysis of debt sustainability of Goa.
They have found a positive relationship between the ratios of primary deficit and GSDP and debt and GSDP. The favourable difference between the rate of growth of GSDP and interest payments on public debt helped the state to achieve fiscal sustainability. They found that the role of the central government is crucial in determining the debt position of the state during the study period.
Thus, the issue of fiscal and debt sustainability has been a matter of concern for all tiers of governments in recent decades. Governments have to ensure a sustainable fiscal policy while discharging their expenditure responsibilities. But to control the burden of public debt by cutting down necessary expenditures may well amount to renege their obligations. At the same time, an unsustainable fiscal policy may lead to further deterioration of state’s economy. Under these circumstances, there is a need to design an appropriate fiscal strategy encompassing all the above issues. A proper assessment of fiscal sustainability helps in smooth functioning of the economy as it can determine the sustainable level of debt and deficits.