State of flux

States’ quality of expenditure could improve

A recent paper by the Reserve Bank of India once again focuses on the quality of
public expenditure in the States and reminds us that revenue expenditure is not
conducive to growth, whereas capital spending is. At a time when States are
loosening their purse strings to boost their electoral prospects, this fact should not
be lost sight of.

The burden of the paper, published in the RBI’s July bulletin, is that a higher quality of public
spending — measured in terms of proportion of capital expenditure and revenue expenditure
to total spending, GSDP and to each other; and the share of ‘development expenditure’ (a
mixed bag that has capital and revenue items) — translates into higher growth. The paper
shows that high quality spending by States (emphasis on capex over revenue spending)
between FY06 and FY10 pushed up their average growth rates, whereas low quality years
such as FY11­15 and FY18­20 dragged growth down. There can be no denying that the Fiscal
Responsibility and Budget Management Act has played a role in improving quality of
spending, even as the initial goal of States achieving a zero revenue deficit has been
shelved. The paper, as well as the RBI’s study of State finances brought out in January,
points out that the States’ capital outlay at 2.9 per cent of GDP in FY23, is well above the
30­year average of 1.9 per cent, not least due to the Centre’s incentives to boost capex.
However, recent research by Bank of Baroda points out that 14 States spent less than 75
per cent of their budgeted capex for FY23. States wait till the end of the fiscal to ramp up
capex, after assessing their fiscal situation. Clearly, more planning and co­ordination is called
for.

Notwithstanding the recent improvements, the elephant in the room is the extent to which
committed expenditures eat into revenue receipts. Of the non­development expenditure of
over ₹14­lakh crore, pension and interest payments account for ₹10­lakh crore. The latter
figure is over 25 per cent of the revenue receipts of ₹38.5­lakh crore in FY23. Non­
development expenditure at over 35 per cent of revenue receipts is way too high. The share
of development expenditure (spending on health, education, labour, irrigation, nutrition and
transport) in total State spending has risen from 52 per cent in FY05 to 63 per cent in FY23
(₹32­lakh crore). To sustain this progress, States should raise non­tax revenues — they can
rationalise property taxes, water rates and other user charges.

The RBI paper, while including development spending in its quality metrics, says it “does not
show a strong association with GSDP growth...This could be due to the lagged effect of
developmental expenditure such as education and health spending on economic growth”.
Since development expenditure contains revenue and capital items, it might make sense to
take a nuanced view of deficits, using metrics such as effective revenue deficit (revenue
deficit less grants for creation of capital assets) and primary deficit (fiscal defcit less interest
payments).

(509 words/ THBL)