Context: The economic crisis induced by the covid-19 pandemic has created a severe fiscal crisis for state governments which are at the frontline to contain COVID-19 pandemic.
More on the news
- The Centre’s ₹1.7 trillion relief package, which is just 0.8% of India’s gross domestic product (GDP), has not come as a great deal for states.
- Even the states too have come out with a relief package of their own.
- Kerala was the first to announce a package of ₹20,000 crore.
- Tamil Nadu, Rajasthan, and West Bengal announced packages of ₹3,280 crore, ₹2,000 crore and ₹200 crore respectively.
- Other states such as Delhi and Uttar Pradesh have also promised pension relief for the old, widowed, and differently-abled and cash handouts for informal sector workers.
Imperative for spending
- Health shocks
- States may need to step up spending, not only to ramp up healthcare provisions
- Kerala’s relief package, which is about 14% of its total budgeted expenditure indicates a higher spending requirement.
- Spending requirements for states such as Maharashtra and Delhi, which have more covid-19 casualties, are likely to be higher.
- Kerala’s legacy of higher investments in health means that it’s better prepared than most others to fight the pandemic.
- Other states could need more resources to ramp up their health infrastructure.
- Economic shocks
- The lockdown has already taken a toll on Goods and services tax (GST) collections and overall revenues of central and state governments.
- There is no alternative to additional borrowing at this point.
- State borrowings are still capped at 3% of gross state domestic product (GSDP) under the Fiscal Responsibility and Budget Management (FRBM) Act.
- It acts as a severe constraint in the borrowing efforts of the State government.
- States were provided a 0.5% relaxation on their borrowing limit during the global financial crisis of 2008-09.
- The requirement for higher borrowings comes at a time when the borrowing costs for state governments have been rising.
- The RBI’s data shows that the gap between yields on State Development Loans (SDLs) and the benchmark rate has increased over time.
- RBI has relaxed limits on Ways and Means Advances (WMA) for state governments by 30% till 30 September, a measure came in as a partial relief.
- Short term
- An additional funding of about 3% of India’s GDP, might be required if states are expected to put up a strong fight against the healthcum-economic crisis.
- The analysis is based on the assumption that affected states might have to spend 15% more than what they had budgeted for 2020-21.
- Even if the affected states were allowed to borrow 3.5% of their GSDP, they would be able to raise only a little more than ₹2 trillion, much short of the required spending.
- So a 50 basis points escape clause in the FRBM will not be enough.
- The situation calls for at least 1.5 percent detour from the FRBM, 2003.
- It is also suggested to suspend FRBM provisions till the health shock is contained.
- If the overall success of containing COVID-19 rests on the shoulders of states, the centre should relax borrowing norms for state governments.
- Medium and Long term
- States must ramp up spending on the health sector, hitherto neglected.
- RBI’s state finances report reveals that only Delhi and Kerala, have spent more than 10% of their total development expenditure on health in FY19.
- As per a CAG report of 2017, even the limited funds allocated to states for healthcare are underutilized and diverted to other schemes.
- States also need to invest in a range of social protection measures to deal with the effects of the lockdown that has crushed the informal economy and brought to standstill the formal economy.
Ways and Means Advances
- The Reserve Bank of India (RBI) gives temporary loan facilities to the central and state governments. This loan facility is called Ways and Means Advances (WMA).
- The Ways and Means Advances scheme was introduced in 1997.
- Purpose : The Ways and Means Advances scheme was introduced to meet mismatches in the receipts and payments of the government.
- Limit of WMA: The limits for Ways and Means Advances are decided by the government and RBI mutually and revised periodically.
- WMA: The government can avail of immediate cash from the RBI, if required. But it has to return the amount within 90 days. Interest is charged at the existing repo rate.
- If the WMA exceeds 90 days: it would be treated as an overdraft (interest rate on overdrafts is 2 percentage points more than the repo rate).
Types of WMA
There are two types of Ways and Means Advances — normal and special.
- A Special WMA or Special Drawing Facility (SDF) is provided against the collateral of the government securities held by the state.
- Normal WMA: After the state has exhausted the limit of SDF, it gets normal WMA. The interest rate for SDF is one percentage point less than the repo rate.
- The number of loans under normal WMA is based on a three-year average of actual revenue and capital expenditure of the state.
Need of Ways and Means Advances
- The WMA facility enables the government to take a temporary short term loan from the central bank, mainly to address the mismatch between its inflow of revenues and outflow of expenditure.
- Flexibility to raise funds: A higher limit provides the government flexibility to raise funds from RBI without borrowing them from the market.
- More funds can help in welfare of poor and vulnerable sections and for the resurgence of the industry.
The Fiscal Responsibility and Budget Management (FRBM) Act, 2003
To make the Central government responsible for ensuring “inter-generational equity in fiscal management and long-term macro-economic stability”.
- Further it sought to ensure that administrators within the current government at the centre, maintain the nation’s finance in an organized manner, so the posterity does not inherit the burden of dealing with unsustainably high levels of debts.
The Act envisages the setting of limits on the Central government’s debt and deficits as well as mandating greater transparency in fiscal operations of the Central government and the conduct of fiscal policy in a medium-term framework.
The government is also required to provide the Parliament details of fiscal indicators such as
- Fiscal, revenue and primary deficit as a percentage of GDP,
- Tax and non-tax revenues as a percentage of GDP
- Central government debt as a percentage of GDP
- Limiting the fiscal deficit to 3% of the nominal GDP:Most recent target includes reducing it to 3.1% by March 2023.
- Debt of the central government to 40% of the GDP by 2024-25.
- Revenue deficit to be brought down to 0%.
Linkages with the states
- To ensure that the States too are financially prudent, the 12th Finance Commission’s recommendations in 2004 linked debt relief to States with their enactment of similar laws.
- The States have since enacted their own respective Financial Responsibility Legislation, which sets the same 3% of Gross State Domestic Product (GSDP) cap on their annual budget deficits.
Escape clause:Section 4(2)
The Centre can exceed the annual fiscal deficit target citing the following grounds
- National security
- National calamity
- Collapse of agriculture
- Structural reforms and
- Decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.