Recent discussions on fiscal governance in India have underscored the growing need for independent fiscal councils at the state level. A research paper by the National Council of Applied Economic Research (NCAER) has recommended the establishment of these councils to enhance the institutional capacity of states in managing their finances effectively.
The Role of Fiscal Councils
Fiscal councils serve as independent bodies that provide objective assessments of state government financial forecasts. Their primary functions include:
- Evaluating revenue and expenditure projections made by state governments.
- Generating their own independent forecasts to compare with government estimates.
- Identifying contingent liabilities and offering recommendations to mitigate financial risks.
By offering impartial financial analysis, fiscal councils can help state governments adopt more disciplined and transparent fiscal policies.
International Precedents: Lessons from the EU
Globally, fiscal councils have been implemented with notable success. The European Union (EU) provides a key example where each member state is required to establish its own fiscal council. Additionally, the European Commission acts as a quasi-fiscal council at the Union level, ensuring rigorous oversight and assessment of budgetary forecasts. This model enhances financial accountability and promotes stable economic governance.
Historical Context and Previous Recommendations
The idea of fiscal councils in India is not new. Various government bodies have previously recommended their establishment:
- The Thirteenth Finance Commission proposed an autonomous fiscal oversight body to report to the Ministry of Finance.
- The Fourteenth Finance Commission highlighted the global advantages of fiscal councils and suggested their implementation.
However, despite these recommendations, the Indian government has so far resisted the idea, citing concerns over potential limitations on the Finance Ministry’s authority.
Addressing Fiscal Challenges: A Forensic Analysis of State Finances
The NCAER paper advocates for a forensic analysis of states with high debt levels. This includes:
- Identifying the root causes of revenue shortfalls and expenditure overruns.
- Learning from historical financial missteps to prevent future fiscal crises.
- Strengthening fiscal responsibility through data-driven decision-making.
State Debt Levels: A Growing Concern
Debt levels among Indian states vary significantly. For example:
- Punjab‘s debt stands at nearly 50% of its State Gross Domestic Product (SGDP), indicating severe financial stress.
- In contrast, Odisha, Maharashtra, and Gujarat maintain debt levels below 20% of SGDP, reflecting better fiscal management.
- Over the past decade, large states have experienced a 10 percentage point increase in their debt-to-SGDP ratios, raising concerns about long-term financial sustainability.
Market Discipline and RBI’s Role
The NCAER paper suggests that the Reserve Bank of India (RBI) should reconsider its intervention policies regarding state debt. Presently, the RBI caps the spreads on bonds issued by highly indebted states, reducing the cost of borrowing. However, reducing such interventions could:
- Strengthen market discipline by forcing states to manage their finances more responsibly.
- Encourage states to implement sound fiscal policies to maintain creditworthiness.
Reevaluating the Finance Commission’s Approach
Another key recommendation is to reassess the role of the Finance Commission in resource allocation. The current approach often incentivizes poor fiscal management by allocating more resources to states with larger revenue deficits. NCAER argues that the allocation formula should be revised to:
- Reward states that demonstrate fiscal prudence.
- Encourage efficient financial planning and reduced dependency on central transfers.
A Call for Stronger Fiscal Institutions
As Indian states continue to grapple with rising debt levels and fiscal challenges, the establishment of state-level fiscal councils could be a game-changing reform. By promoting transparency, accountability, and disciplined financial management, these councils can help states navigate their economic future with greater stability and efficiency. Implementing such recommendations would mark a significant step toward strengthening India’s overall fiscal framework and ensuring long-term economic resilience.