Economy
Data dive: How freebies are hurting already stressed state finances
Summary
- Most states that went to the polls in 2023 or 2024 saw their fiscal deficit as a share of their gross domestic product rise from the previous non-election year.
Maharashtra and Jharkhand are going to polls amid heated campaigns that saw ideological clashes, political wrangling, and promises of several free goods and services, colloquially known as freebies.
Political parties make election promises such as cash transfers to women, free gas cylinders, and free electricity to woo voters. This competitive populism, nonetheless, has reached a feverish pitch in several state elections in recent years at the cost of fiscal prudence.
Most states that went to polls in 2023 or 2024 saw their fiscal deficit as a share of the gross state domestic product (GSDP) rise compared to the previous non-election year, showed a Mint analysis based on the fiscal data of 19 large states by Emkay Global.
The rise is between 0.2 and 0.9 percentage points, with Telangana and Rajasthan leading the list. Telangana and Rajasthan held assembly elections in November 2023.
“Financial assistance schemes for women have been very popular, and farm loan waivers and free electricity schemes have also been announced," said Madhavi Arora, chief economist at Emkay Global, in a report last month.
“This is likely to kick off a trend across states as it will be extremely difficult to resist pressure to enact similar policies. Pressure on fiscal math is therefore guaranteed, with upside risks for 2024-25 already emanating," Arora added.
Both the Union and state governments had to expand their spending massively during the pandemic years even as revenues slumped, leading to higher fiscal deficits. They embarked on a path of fiscal consolidation but a differentiator has since emerged: the Centre is reducing its fiscal deficit, but states are seeing a rise again.
The Centre’s fiscal deficit is budgeted at 4.9% of GDP in 2024-25, down from 5.9% in the previous year. States, on the other hand, could see their deficit rising for the second year in a row, with the FY25 figure likely to cross 3%, the highest since FY21, when the pandemic was being dealt with in full swing.
Muddled maths
States have been in a tight ropewalk in terms of their financial situation. Uneven economic growth after the pandemic coupled with a shortfall in tax revenues have crimped their ability to generate sufficient revenues.
States’ revenue receipts grew just 7% in 2023-24 compared to double-digit growth seen in the previous two fiscal years, according to data from Emkay Global.
Overall revenues have been dragged down by slow growth in states’ own tax revenue (OTR) streams such as sales tax/value added tax and excise. OTR grew in single digits in 2023-24: 9% year-on-year, which was half the budgeted growth of 17%. While this could be partly due to the base effect, the subdued growth is raising alarm, adding to reduced state autonomy over tax collection since the introduction of GST.
On the expenditure side, there is no sign of relief as states have taken on several populist measures on top of already heavy subsidy commitments. “The fiscal strain is not entirely because of lower revenues alone. There are expenditures under various schematic heads that have not been rationalized for a long time, many of which need to be discontinued," said N.R. Bhanumurthy, director at Madras School of Economics.
Overestimation and cuts
States have budgeted higher revenue spending in the current financial year, with growth more than doubled from the previous year. On the other hand, despite the push from the Centre, capital expenditure growth is budgeted to slow down.
However, states tend to overestimate their revenue collections and correspondingly their expenditure plans in budgets. In FY24, 19 large states missed their revenue and expenditure estimates by 7-11%. With states’ propensity to slip on their budgeted revenue and expenditure plans high, promises of free goods and services add another layer of pressure.
With freebies embedded in the country’s political fabric, the challenge for states is to look at avenues to bump up revenues. Experts say that states need to expand their tax base to raise tax revenue and make state-run public sector undertakings more efficient, among other steps.
Some states pushed to the brink are being forced to rationalize expenditure to maintain fiscal sustainability and curtail borrowings. Himachal Pradesh, whose debt has more-than-doubled in the past five years, has called for a ‘review’ of subsidies.
“The market can penalize states that are going for excessive or wasteful expenditure. The borrowing rate will go higher for states that mismanage their fiscal conditions," said Bhanumurthy.
